The Case Against the Implementation of Loyalty Shares in Spain

The Spanish Ministry of Economy has recently released a new bill that, among other aspects, proposes an amendment of the Spanish Companies Act to allow listed companies to adopt loyalty shares. These shares will confer additional voting rights to those shareholders staying in the corporation for at least two years. For that purpose, the company only needs to approve the adoption of loyalty shares by a qualified majority. Therefore, following the Italian (rather than the French) model of loyalty shares, the adoption of loyalty shares in Spain will be done as an opt-in rule.

According to the Spanish Government, the introduction of loyalty shares seeks to fulfil three primary objectives: (i) preventing short-termism in Spanish capital markets; (ii) promoting the long-term engagement of shareholders in accordance with the European Directive; and (iii) making Spanish capital markets more attractive internationally.

In a recent note, entitled ‘A Critical Analysis of the Implementation of Loyalty Shares in Spain’, based on my response to the Spanish Government during the public consultation process, I have argued that the implementation of loyalty shares in Spain not only is unnecessary—since Spanish capital markets do not face a problem of short-termism—but it can also undermine, rather than improve, the long-term engagement of shareholders and the competitiveness of Spanish capital markets.

First, as it has been convincingly argued by Professor Mark Roe, there are no reasons to conclude that there is a short-termism problem in US capital markets. Therefore, if this problem does not clearly exist in the United States, where the greater presence of activist shareholders makes the existence of short-termism more likely, it will be difficult to believe that Spanish capital markets face a problem of short-termism. In Spain, the existence of powerful controlling shareholders makes insiders less subject to the pressure of the (few) activist shareholders initiating a campaign against a Spanish public company.

Second, while some authors have shown that the rise of hedge fund activism may harm the value of the firm in the long-term, another group of scholars have shown the opposite result. Therefore, the empirical evidence is not conclusive, even in countries with a higher risk of short-termism such as the United States.

Third, the use of loyalty shares does not seem an effective tool to promote the long-term engagement of shareholder. Indeed, as loyalty shares will favour both majority and minority investors equally, the latter will not have incentives to be more engaged. It will still have incentives to be rationally apathetic. Therefore, the adoption of loyalty shares will make controlling shareholders more powerful without promoting more engagement by minority investors.

Fourth, while the existence of short-termism is not a problem in Spanish capital markets, the lack of confidence by minority investors can be due to the risk of entrenchment and tunnelling by controlling shareholders. Moreover, this lack of confidence by minority investors can be exacerbated by the fact that, unlike other jurisdictions, Spanish corporate law: (i) does not allow minority investors to directly appoint an independent director, as it happens in Italy; (ii) does not grant minority shareholders the exclusive power to approve related party transactions entered into with the controlling shareholder, as it happens in Hong Kong and Israel; and (iii) does not protect minority investors through a sophisticated capital market and the use of other legal devices such as class actions, as it happens in the United States. Therefore, making controllers even more powerful with the use of loyalty shares may exacerbate the major corporate governance problems existing in Spanish companies. As a result, Spanish capital market will become less attractive for public investors.

Finally, the implementation of loyalty shares, as well as other reforms proposed by the Government (including the adoption of semi-annual reporting), may reduce the level of liquidity, transparency and informational efficiency of Spanish capital markets. Therefore, since many investors might not have incentives to invest in Spanish companies and, if so, to engage in shareholder activism, minority investors will be subject to an ever higher risk of opportunism by controllers.

In my opinion, the Spanish Government should not allow public companies to adopt loyalty shares. And in case of doing so, it should require the adoption of these shares before going public, as it happens in many countries with the use of dual-class shares. Otherwise, controllers may opportunistically adopt these shares taking advantages of the greater level of dispersion, asymmetries of information and rationally apathy existing among public investors. Moreover, by requiring the adoption of these shares before going public, controllers will only have incentives to go public with loyalty shares if they think it can also be in the interest of minority investors. Otherwise, they will face the risk of having an unsubscribed or highly discounted offering. Therefore, the requirement to adopt loyalty shares pre-IPO may serve as a powerful tool to protect public investors while making Spanish corporate law more flexible by allowing public companies to use shares with multiple voting rights.

Aurelio Gurrea-Martínez is an Assistant Professor of Law at Singapore Management University.