Shareholder protection in share issuances: a comparative law and economics approach

A PhD teaser by Tom Vos

Corporations need cash to finance their activities. Issuing shares to investors is an important way of raising capital, with listed corporations raising hundreds of billions globally through share issuances. Share issuances also come with a risk, as they can dilute the voting and financial rights of the existing shareholders of the corporation. Some dilution of the existing shareholders may be necessary to raise capital successfully. However, “insiders” of the corporation, such as a significant shareholder or manager of the corporation, may have incentives to use their influence over the corporation to cause the corporation to issue shares for their personal benefit, to the detriment of the existing shareholders. This is an example of an “agency problem”, where the insiders (the agents) have the power to make decisions that affect the welfare of the shareholders (the principals), who have imperfect information about the insiders’ performance.

To be precise, I have distinguished three different problems in share issuances. Firstly, the problem of cheap-stock tunneling occurs when insiders of the corporation use their influence over the corporation to cause the corporation to issue shares to themselves or to other related parties at a price that is lower than the true value of the shares, thereby diluting the minority shareholders financially. Secondly, insiders can also cause the corporation to issue shares to themselves or to friendly parties, in order to grab or entrench their control of the corporation. Thirdly, insiders may use a share issuance to transfer cash (or other assets) to the corporation without a proper business purpose. Insiders may then try to extract this cash from the corporation for their personal benefit, for example through related party transactions with the corporation, through excessive executive compensation, or by engaging in acquisitions to increase the size of the corporation to inefficient levels for personal prestige and perks (so-called “empire building”).

Jurisdictions around the world have recognized such agency problems and have adopted several legal strategies to reduce “agency costs” in share issuances, including: shareholder approval (Part 3 of my doctoral thesis), pre-emption rights (Part 4), general standards (Part 5) and procedures for share issuances to related parties (Part 6). I have analyzed to what extent these strategies help to protect shareholders against one or more of the three problems in share issuances, which I have called the anti-tunneling function, the control protection function and the disciplining function of these shareholder protections, respectively.

However, legislators must also be wary of regulating share issuances too strictly. Doing so could prevent corporations from quickly and cheaply raising capital, thereby harming shareholders instead of protecting them. The costs of shifting power back to shareholders are sometimes referred to as “principal costs”, which need to be balanced against the reduction of agency costs. Jurisdictions differ significantly in how they strike this balance between agency costs and principal costs in the protection of shareholders in share issuances. These different approaches have not yet been subject to a thorough comparative and economic analysis, including a review of the empirical evidence on how the regulation of share issuances plays out in practice.

My doctoral thesis aims to fill this gap. I asked the question: “what explains the similarities and differences in the protection of shareholders against dilution in share issuances by listed corporations in the US, the UK, France and Belgium, and how can the efficiency of the respective legal frameworks be improved while taking into account the legal and societal context of the selected jurisdictions?” To answer this question, I developed an analytical framework (Part 2 of my doctoral thesis), based on the functional method of comparative law and the economic analysis of law. I then used this framework to compare, explain and evaluate the different approaches to shareholder protection in share issuances.

Below, I summarize the policy proposals that I made that are most relevant for Belgian law. Those who are interested in learning more are invited to consult the longer summary of my doctoral thesis here, or contact me for a more elaborate discussion of shareholder protection in share issuances.

Stricter limits on authorizations to the board

A first set of policy proposals that I have made relates to the limits on authorizations to the board to issue shares. Belgian law allows the general meeting to authorize the board to decide on a share issuance. These authorizations have a maximum duration of five year and a maximum amount of 100% of legal capital under Belgian corporate law. Guidelines by the proxy advisors Glass Lewis and ISS impose stricter limits, however: 100% (Glass Lewis) and 50% (ISS) of legal capital for pre-emptive share issuances, and 20% (Glass Lewis) and 10% (ISS) for non-pre-emptive share issuances. However, I provide empirical evidence that these guidelines are almost always ignored by listed corporations outside the BEL 20, especially for authorizations to disapply pre-emption rights. This is in contrast to the UK, where the Pre-emption Guidelines and the Share Capital Management Guidelines contain stricter limits on authorizations that have a larger impact in practice. I also provide empirical evidence that the limits on authorizations in France are stricter than in Belgium, although not as strict as in the UK. 

I argue that stricter limits on authorizations fulfill a disciplining function towards insiders, by requiring pre-emption rights or shareholder approval for large share issuances. However, I do not believe that stricter mandatory regulation of authorizations is justified, because one size of authorization may not fit all corporations. I do argue that Belgium should empower shareholders to monitor the authorizations of listed corporations more strictly, in line with the guidelines of international proxy advisors and the experiences in the UK and France. For example, I have argued that Belgian market participants should establish “homegrown” guidelines that are adapted to local market conditions, as is the case already in the UK and France. Such guidelines would likely have a stronger influence than the current guidelines by international proxy advisors. In addition, I have also argued in favor of a shorter maximum duration for authorizations, for example, 26 months (as is required by French law) or one year (as is market practice in the UK). In practice, Belgian corporations almost always opt for the maximum allowed by law, five years. Shorter authorizations would give the shareholders more opportunities to hold the insiders accountable for the proper use of authorizations to issue shares. Finally, I have argued that Belgian law should require a separate shareholder vote for authorizations to disapply pre-emption rights, as is required by law in France and as is market practice in the UK. Currently, the whole authorization, including the authorization to disapply pre-emption rights, is presented in a single resolution in Belgium. Separate resolutions would prevent shareholders from being coerced into voting for excessive authorizations for non-pre-emptive share issuances out of a fear of voting against any form of authorization for the corporation, which is likely inefficient.

A second set of policy proposals relates to the scope of application of the procedures for share issuances to related parties. A first policy proposal for Belgium is to eliminate the overlap and inconsistencies between the general procedure for related party transactions in article 7:97 Belgian Companies Code (including the voting prohibition for directors “involved” in the transaction) and the specific voting prohibition in article 7:200, 2° Belgian Companies Code for directors who are a “de facto representative” of the counterparty in the share issuance. The different concepts used to define the scope of the voting prohibition are confusing. Neither procedure is inherently better than the other, but I have argued that the general procedure for related party transactions suffices, because any specific elements for share issuances can easily be incorporated into the general procedure through specific exceptions, as is currently already done with the exception for pre-emptive share issuances. 

Secondly, I have argued in my doctoral thesis that the definition of “related party” should be broadened in Belgium. For example, share issuances to entities in which related parties have a financial interest that is larger than their financial interest in the corporation issuing the shares are currently not always covered by the procedures, especially if the interest is not a controlling one. I have argued that this should be changed. In addition, while some family members of related parties are covered by the procedures in Belgium, the scope of the procedures should be extended beyond the current, very narrow list of family members (essentially only the spouse, domestic partner or children of the insider). Finally, the personal scope of voting prohibitions for directors and shareholders who are thought to have a conflict of interest in the transaction should be extended. The current scope often does not take into account more indirect ties of the director or shareholder with the counterparty in the share issuance.

Thirdly, some of the legal concepts that define the scope of the procedures for related parties in Belgium lead to a large amount of legal uncertainty and should be clarified, such as the concept of “de facto representative” and the concept of a director “involved” in the transaction. However, to some extent, open-ended, standard-like concepts are inevitable in the definition of the scope of the procedures, such as the concept of a “material financial interest in the transaction” that I have proposed. I have therefore argued that enforcement of these rules should be centralized with the financial supervisor (as is currently the case in the UK), in order to ensure a more consistent interpretation of open-ended concepts and the gradual transformation of open-ended concepts into specific rules.

Fourthly, I have also made policy proposals with regard to the application of the procedures to pre-emptive share issuances in which related parties participate. Legislation in Belgium currently exempts pre-emptive share issuances from the procedures of related party transactions. The idea is that pre-emption rights eliminate the possibility of cheap-stock tunneling, as shareholders can simply exercise their pre-emption rights if the issue price is low However, an economic analysis suggests that cheap-stock tunneling is still possible in pre-emptive share issuances, due to the presence of information asymmetries, the lack of transferable rights and the presence of private benefits for insiders. I have therefore argued that pre-emptive share issuances should only be exempted from the procedures for share issuances to related parties if the insiders disclose whether they will participate, the rights are transferable, and the transaction gives no material private benefits to any insiders. Disclosures by insiders and transferable rights are already market practice in Belgium, but the monitoring of private benefits remains important. I have also argued that pre-emptive share issuances in which insiders commit to not participate more than pro rata could be exempted from some of the procedures, because there is no risk of cheap-stock tunneling.

Finally, I have also analyzed the application of the procedure for share issuances to related parties to public offerings and private placements in which insiders participate together with outside investors. In Belgium, most scholars argue that the procedures only apply if the related parties were guaranteed a certain allocation of shares, and not if the insiders merely communicated their intent to participate and the shares were allocated on the basis of objective criteria. I have argued, however, that even so-called objective allocation criteria may favor insiders, as the bookbuilding procedures typically used in these transactions still leave investment banks a large discretion, which the empirical evidence suggests can be abused. Instead, I have proposed a simpler criterion for applying the procedures for share issuances to related parties: they should only apply if related parties participate more than pro rata in the transaction. The reason is that the related parties only have an incentive to underprice the share issuance if they increase their ownership percentage in the corporation, which justifies additional shareholder protection.

A final set of policy proposals relates to the introduction of stronger procedural safeguards for share issuances to related parties, but with more proportionality in their scope of application. The empirical evidence suggests that both approval by independent directors and by a majority of the minority shareholders can be effective in reducing cheap-stock tunneling. There are also strong arguments that these procedural safeguards are complementary and that a combination of both may be justified in some cases. In addition, the evidence suggests that fairness opinions can play a useful role in protecting shareholders. The combination of these procedural safeguards is currently already used to some extent in the US and the UK. However, Belgium currently does not combine approval by disinterested directors and by disinterested shareholders for the riskiest transactions, which I have argued should be changed.

However, these procedural safeguards for share issuances to related parties also come with potentially significant principal costs. Nevertheless, as share issuances increase in size, the (potential) dilution for minority shareholders also becomes larger, while the principal costs are unlikely to increase proportionately. In addition, I have argued that the presence of a controlling shareholder undermines the effectiveness of certain strategies, for example of independent directors. I have therefore argued that for the largest transactions and for transactions with a controlling shareholder, the combination of these procedural safeguards is justified, while only one or even none of the procedural safeguards can be required for smaller and less risky share issuances. Such a proportionate approach is to some extent already used in Belgium, which only subjects related party transactions above a certain threshold (1% of net assets) to the procedure. Such a proportionate approach should be taken further, with additional thresholds that lead to the application of additional procedural safeguards. In my view, stricter procedures coupled with high thresholds of applications strike a better balance between shareholder protection and flexibility than the current system with less onerous procedures that apply to even very small share issuances. I do recognize that the precise thresholds require further research and debate, although setting a precise quantitative threshold will inevitably be somewhat arbitrary. 


In conclusion, it is fair to say that the topic of shareholder protection in share issuances is complex. I hope (and believe) that my doctoral thesis has been able to reduce this complexity and provide a better understanding of the agency problems present in share issuances, although I am fully aware that it has also raised many new questions. My doctoral thesis has provided further insight into how and why the US, the UK, France and Belgium protect shareholders differently in share issuances. I believe that this will help scholars who analyze share issuances as well as practitioners who structure them. The doctoral thesis has also made several proposals on how the current legislative framework in the different selected jurisdictions should be changed. Hopefully, this will inspire policy makers inside and perhaps outside the selected jurisdictions. 

On 20 December at 5 pm, Tom Vos will defend his doctoral thesis titled “shareholder protection in share issuances: a comparative law and economics approach” at the KU Leuven. Tom wrote his PhD under supervision of prof. dr. Veerle Colaert and prof. dr. Marieke Wyckaert. Tom is currently a researcher and visiting professor at the Jean-Pierre Blumberg Chair at the University of Antwerp. The blogpost below offers a “teaser” of his doctoral thesis. Those who are interested in hearing more about Tom’s research can register for online participation to the PhD defence by e-mailing A longer summary of his doctoral thesis is also available here

Tom Vos
PhD candidate (KU Leuven)
Visiting professor at the Jean-Pierre Blumberg Chair (University of Antwerp)

Author: Tom Vos

Tom Vos is a visiting professor at the Jean-Pierre Blumberg Chair of the University of Antwerp, where he conducts research and teaching in the field of corporate governance. He is also affiliated as voluntary scientific collaborator with the Jan Ronse Institute (KU Leuven). His current research interest is short-termism in corporate governance.

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