I have written about certain idiosyncrasies of Swiss capital market regulations before. Most Swiss corporations started as family firms and, for a long time, outside shareholders were considered a mere nuisance and treated accordingly. Some remnants of that attitude remain. While there is now a reasonably modern set of rules governing listed firms, there are many exceptions. It is possible to have share classes with different voting rights. As an example, there may be one share class that has only one fifth of the par value of the second share class but with both classes having one vote per share. Thus, in this example, the privileged shareholders – typically the founding family – control the corporation with less than twenty per cent of the capital. There is also the usual rule that when a purchase of shares leads to a holding that is greater than a certain threshold, an offer to all remaining shareholders must be made at the highest price that was paid before. But Swiss companies may decide to “opt out” of this rule, i.e., simply ignore it. The combination of privileged voting rights and opting out allows the controlling shareholders to sell their block to a buyer who will not need to make any offer to the outside shareholders. Naturally, the controlling families routinely insist that they have no intention of ever selling. This is true until the day on which they change their mind, which is what happened recently to Sika, a chemical firm, with Saint Gobain the buyer. The outside shareholders were not amused since the price of their share class dropped by almost thirty per cent – the privileged share class is not listed – and they are now trying various legal tricks to prevent the sale from happening. They are led by the board of directors who had not been informed. It is turning into a bit of a farce with the board trying desperately to present itself as the champion of the outside shareholders – whom they had previously completely ignored. The only obvious winners will be the legal advisors to the various parties.
Not surprisingly, there are now also calls to make these kinds of practices illegal. But why should they be? The outside shareholders presumably knew what they were getting into. Nobody had to buy Sika shares or is forced to buy Roche Genussscheine or Swatch bearer shares, which give you the right to a dividend but not much else – and potentially a very nasty surprise. By the way, the issue is not limited to Switzerland; even some of the newly listed US internet stocks have similar arrangements.
So why should we care? Because some of those outside shareholders may well feel obligated to hold those securities. Those who hold Swiss equities in the form of an index fund will automatically buy all of them if the fund pursues a full replication strategy – which is the only reasonable way to invest if you insist on an indexed strategy, by the way – as long as they are included in the index. But even some (pseudo)active investors who are slaves of benchmarks may not be willing to take the tracking error risk of ignoring those securities completely. These investors will automatically have to live with the (small) risk of having a change in control without having the slightest voice in the process.
What, if anything, should be done? I feel that a rule change – which would essentially expropriate the founding families – would be too drastic. Corporations should have the right to arrange their affairs largely as they like. If they want to issue the kind of toxic securities that some of them do, let them. But why should we be forced to own them, even if indirectly through their inclusion in stock market indices? One very obvious way to eliminate the problem would be to purge the shares of offending firms from the major indices. Thus, the shares of all corporations that issue multiple share classes with differential voting and property rights would no longer be included; only the shares of companies that subject themselves to clean one share-one vote rules would remain. As a result, no index fund investor would be obligated to hold those toxic shares. This would reduce demand, of course, and might have a negative impact on the share price – increasing the firm’s cost of capital as a result. The families could continue to run “their” companies as they pleased but they would at least have to pay a certain price. This might even encourage them to review their approach. Index providers could continue to offer the traditional indices that include the toxic shares but add “clean” indices that eliminate them.