The European Commission appears to pursue the harmonisation of national corporate governance for the sake of harmonisation itself
Jasper Lau Hansen
In this post I explained why the approach taken by the European Commission and now by the European legislator to the liberalisation of multiple‑vote or plural‑vote shares seems to me misguided. What follows sets out a number of reasons why I believe that the Court of Justice should annul this legislation. Europe lacks the competence to regulate multiple‑vote shares in the way it has done. European regulation clearly infringes the principle of subsidiarity, and the harmonisation of national legislation for the purpose of removing obstacles or barriers to freedom of establishment—the other legal basis relied upon by the Commission—not only lacks justification in this case but is actually counterproductive: harmonisation contributes to segmenting the single market rather than eliminating barriers to the free movement of capital and, more generally, to building a single capital market in Europe. In the
COMMISSION STAFF WORKING DOCUMENT IMPACT ASSESSMENT REPORT Accompanying the documents Proposal for a DIRECTIVE OF THE EUROPEAN PARLIAMENT AND OF THE COUNCIL amending Directive 2014/65/EU to make public capital markets in the Union more attractive for companies and to facilitate access to capital for small and mediumsized enterprises and repealing Directive 2001/34/EC; Proposal for a DIRECTIVE OF THE EUROPEAN PARLIAMENT AND OF THE COUNCIL on multiple-vote share structures in companies that seek the admission to trading of their shares on an SME growth market; Proposal for a REGULATION OF THE EUROPEAN PARLIAMENT AND OF THE COUNCIL amending Regulations (EU) 2017/1129, (EU) No 596/2014 and (EU) No 600/2014 to make public capital markets in the Union more attractive for companies and to facilitate access to capital for small and medium-sized enterprises {COM(2022) 760 final} - {SEC(2022) 760 final} - {SWD(2022) 763 final}
one reads:
There is a public policy imperative for the EU to act swiftly. The policy options outlined in this impact assessment would address the issues that stakeholders have repeatedly highlighted in recent years as factors hindering EU companies’, and particularly SMEs’, access to public equity capital markets.
No other policy measure adopted in isolation by the Commission would be capable of resolving the specific problems identified in this impact assessment, which stem from a concrete regulatory failure that can only be remedied through legislative amendment of the relevant regulation.
Market developments, such as the emergence of FinTech and other recent trends in the financial services sector, are not expected to materially improve the situation with regard to the problems identified.
And what exactly is the problem that neither the market nor other Commission measures can be expected to resolve? Wait a moment. While explaining it, the Commission tells us that its proposal is the best one and that it respects the principle of proportionality because it carefully balances
the reduction of administrative burdens and increased flexibility for issuers, on the one hand, and ensuring adequate and effective investor protection as well as preserving market integrity, on the other.
Only then does the Commission address the “legal basis” for its harmonising intervention:
The legal basis of the Prospectus Regulation and of MAR is Article 114 of the Treaty on the Functioning of the European Union (TFEU), which confers on the EU institutions the competence to establish appropriate provisions aimed at the establishment and functioning of the internal market. Article 114 TFEU would also be relevant for the introduction of EU rules on multiple‑vote share (MVR) structures.
Why must multiple‑vote shares be regulated at European level to achieve the “establishment and functioning of the internal market”? As always, according to the Commission,
The existence of divergent rules among Member States creates an uneven playing field for companies incorporated in different Member States.
This argument, as my grandmother used to say, works “for everything and for nothing.” ("para un barrido y para un fregado"). It justifies any European intervention, because it is inconceivable that the law of 27 different States—some of them with multiple sub‑state legal systems—should be identical, just as it would be inconceivable for the official languages of the 27 States to be identical. Since the argument proves too much, it proves nothing.
The Commission must specifically justify how the existence of different national regulations within the EU regarding multiple‑vote shares (whether they are lawful or not, whether they are permitted for all public limited companies or only unlisted ones, what limits exist on their issuance and extinction, etc.) impedes the functioning of the internal (capital) market.
The Commission’s argument that “the existence of divergent rules… creates an uneven playing field for companies incorporated in different Member States” is simply nonsense —or, to put it less bluntly, fallacious. Any difference in the legal regime applicable to an Italian company as compared with a French one that affects the “price” of their shares could equally be eliminated by the European Commission on the grounds that it “creates an uneven playing field.”
Spanish, Italian or Estonian investors can choose whether to invest in an Italian or a French company and, if they were completely free to do so, they would choose the Italian company because Italian law is more investor‑friendly on points X, Y and Z, and they would choose the French company because French law is more investor‑friendly on points R, S and T. What they would really like is to invest in an Franco‑Italian company that combines everything good in Italian law and none of the bad, everything good in French law and none of the bad—and all at once.
Differences in legal regimes are unavoidable, but that does not mean that they prevent the existence of a level playing field and if they do impede a level playing field, the market will take care of it. How? Italian companies (less attractive to investors because they “suffer” from Italian law that is less favourable to investors) will receive fewer investor funds, while French companies will receive more. The result will be an efficient allocation of resources. And the Italian legislature will have incentives—if it wants to attract investment to Italian companies—to amend those Italian rules che non piacciono agli investitori. And vice versa. The Spanish legislature, observing this market evolution, will have incentives to imitate the French legislature and to “flee” from the ideas of the Italian legislature. In the long run, all legislators will have eliminated the rules most detested by investors.
What is wonderful is that the main advantage of leaving the harmonisation of national legislation to the market—and to competition among legislators—is not the one just described. There is another advantage, far more valuable for Europeans: the market will select the most efficient regulation of multiple‑voting shares—the one that investors like best. This is the default rule: “We Europeans believe in freedom.” This is not an area where there is a need to protect disabled persons, vulnerable groups or individuals unable to protect themselves. Investors know what they want, and if they like multiple‑vote shares—or dislike them—entrepreneurs and promoters of companies that appeal to the public for investment will provide multiple‑vote shares—or not. That is exactly what has happened in the United States, where freedom prevails.
Therefore, unless the European Commission argues that Italian investors cannot invest in French companies or vice versa (i.e. barriers to trade between States), harmonising the regulation is not justified by the need to build a single market. But the Commission thinks—rather, does not think—otherwise:
Indeed, companies domiciled in a Member State that prohibits multiple‑vote share structures would be required to relocate their registered office to another Member State if they wished to list with such a structure in order to comply with the law of the relevant State, thereby increasing IPO costs. By contrast, a comparable company already incorporated in a Member State that allows MVR structures would not have to incur such costs.
This is an even greater piece of nonsense (that is, another fallacy). First, one could equally say that
“companies domiciled in a Member State that prohibits multiple‑vote share structures would be required to relocate their registered office to another Member State if they wished to include such a structure in their articles of association, in order to comply with the relevant State’s law, thereby increasing incorporation costs and the costs of attracting investors who acquire shares at formation or on a capital increase.”
In other words, the Commission itself undermines the justification for the scope of application of the proposed Directive: why force States to allow multiple‑vote shares only for companies that intend to list on the stock exchange and not for all public limited companies? The level playing field is equally distorted.
A much better argument could have been made. The Commission could have said that having multiple‑vote shares is particularly valuable for listed companies (for the reasons explained here), and that a national prohibition therefore harms companies incorporated under that State’s lex societatis. In that case, however, what the Commission should do is persuade States of the merits of allowing multiple‑vote shares for listed companies, not impose anything on them—both because States have the appropriate incentives (they will not want to harm companies governed by their lex societatis) and because the Commission cannot be sure which is the best regulation of multiple‑vote shares. Determining it through negotiation involving hundreds of actors and under the devilish European decision‑making process is a bet on ending up with a three‑humped horse when we were trying to design a gazelle.
Accordingly, the Commission cannot simply claim that companies subject to one national law bear different costs from those subject to another as a justification for legislative harmonisation. It borders on impudence that this weighing of costs is done by sheer guesswork. What I mean is that it may well be more efficient to prohibit multiple‑vote shares in certain contexts and to allow them in others. For example, in countries such as Bulgaria, where agency costs in the corporate realm are assumed to be very high, a formalistic and strict imposition of the “one share, one vote” principle may be efficient because it reduces opportunities for insiders to appropriate private benefits of control. But it is certainly inefficient in Germany. And Germany, sooner or later, will “wake up” and change its legislation. Thus, prohibiting multiple‑vote shares increases the value of Bulgarian companies and reduces their cost of capital but reduces the value of German companies and increases their cost of capital. Again, European‑level harmonisation cannot be efficient when efficiency requires regulation to be adapted to local circumstances—circumstances known to the national legislator and unknown to the European legislator. And this applies, naturally, only where mandatory regulation is necessary at all.
The next Commission absurdity–fallacy is that European investors are idiots ('el Luisma es tonto') and
in some cases, due to these additional costs and considerations, companies might even choose not to list at all, that is, not to access public capital markets, thereby depriving themselves of an alternative source of funding and placing themselves at a competitive disadvantage vis‑à‑vis companies in Member States that allow multiple‑vote share structures.
The stupidity here is that the Commission seems unaware of the marginalist revolution. Ceteris paribus, the fact that Spanish law prohibits multiple‑vote shares in listed companies (while anything goes in private limited companies) merely marginally increases the cost of capital for some companies for which a plural‑vote structure would be efficient. This is because alternative—though somewhat costlier—mechanisms exist to achieve the same outcomes, such as pyramids, shareholders’ agreements, the issuance of non‑voting shares or the granting of economic privileges to shares with lower nominal value and thus lower voting power. At the same time, the prohibition may reduce the cost of capital for other listed companies for which plural‑vote shares would be inefficient because they increase agency costs.
What is incomprehensible—and here the appropriate insult is to call the European Commission hypocritical—is that Europe does not ensure that an Italian company can change its lex societatis easily and at low cost, and thus “move” freely across Europe choosing the national law that suits it best. In fact, the European Union is only justified in harmonising national law when this is a more efficient way of facilitating movement than eliminating the costs and barriers that prevent persons, goods, companies or capital from “moving” to another Member State. That is the first subsidiarity in the European Commission’s “choices.”
The Commission’s final argument is even more stupid, i.e. equally fallacious:
Finally, the growing trend for EU companies to operate cross‑border underlines the need for common European company law mechanisms, including the possibility to depart from the “one share, one vote” principle through the issuance of multiple‑vote shares. There is therefore a significant obstacle to the creation of a single market that an EU rule on MVR structures would seek to eliminate.
What does cross‑border activity have to do with the ownership structure of the company that carries out such activity? If Mercadona sells in Portugal, is it relevant whether Mercadona SL has multiple‑vote shares? The Commission’s argument verges on idiocy.
The Commission adds that
Article 50(1) TFEU and, in particular, Article 50(2)(g) TFEU may also be relevant for introducing EU provisions on MVR structures. These provisions confer competence on the EU to intervene to attain freedom of establishment with respect to a particular activity, in particular “by coordinating, to the necessary extent, the safeguards which, for the protection of the interests of members and others, are required by Member States of companies or firms within the meaning of the second paragraph of Article 54 TFEU, with a view to making such safeguards equivalent throughout the Union.” Recourse to this legal basis is possible where the objective is to prevent the emergence of current or future obstacles to freedom of establishment arising from divergent developments of national laws. The emergence of such obstacles must be likely and the measure in question must be designed to prevent them.
Refuting the Commission at this point seems straightforward: the regulation introduced by this Directive does not affect freedom of establishment. It affects the decision of an established company whether to go public, depending on whether the applicable law allows it to include multiple‑vote shares in its articles.
Where the European Commission becomes entirely indefensible, however, is in its argument that the legislative intervention complies with the principle of subsidiarity:
Pursuant to Article 4 TFEU, EU action to complete the internal market must be assessed in light of the subsidiarity principle enshrined in Article 5(3) TEU. According to that principle, action at EU level should only be taken where the objectives of the proposed action cannot be sufficiently achieved by the Member States acting alone and therefore require intervention at Union level.
This is quite amusing:
The legislation applicable to issuers and trading venues is largely harmonised at EU level, leaving limited scope for Member States to adapt that framework to local conditions. Consequently, changes to EU legislation are necessary to achieve the desired improvements.
Indeed—but this has nothing to do with multiple‑vote shares, which are not regulated at EU level because in 2002 the European Commission quite rightly considered that legislative intervention was not justified under the principle of subsidiarity.
Moreover, EU action is more appropriate insofar as the initiative aims to support cross‑border listings and the trading of securities throughout the Union in order to further integrate and scale up European capital markets. As regards MVR structures, if no EU‑level action is taken, it is very unlikely that all Member States that currently do not allow such structures will unilaterally amend their rules in the near future and without external incentives. This is due to various factors, including historical factors, stakeholder pressures, past experiences and the fact that company law, developed over centuries, is often perceived as particularly complex. Any delay in allowing such structures across the EU would risk continuing to deprive some companies—namely those in Member States that prohibit them—of adequate financing opportunities or impose additional costs on them, ultimately pushing them to list in third countries and relocate there. Finally, even if Member States were to act, approaches could differ substantially, potentially leading to greater fragmentation.
It should be assessed whether the objectives could be better achieved through EU‑level action (the so‑called “European added value test”). Given the limited flexibility to adapt MAR and the Prospectus Regulation to local conditions, EU‑level legislative action appears to be the most appropriate means of reducing the administrative burden on companies accessing public markets. By virtue of its scope, EU action could reduce administrative burdens for issuers while safeguarding market integrity and investor protection, thus ensuring a level playing field.
For a refutation of these arguments I refer to this post, which excerpts a paper by Jesper Lau Hansen that I consider “devastating”: this Directive is not about securities markets. It is about corporate governance, and the EU has no competence over corporate governance unless it derives from the realisation of the freedoms of movement and the removal of obstacles to the single market. Hansen’s distinction between the single capital market and the regulation of company law concerning corporate governance is decisive. The Commission is obliged to remove barriers preventing a Portuguese investor from investing savings in a Danish company, but it lacks competence to guarantee anyone that the public limited company in which they are a shareholder may issue shares with enhanced voting rights. That decision—whether company law should allow or prohibit plural‑vote shares—belongs to the States, and the EU needs a specific legal title to assume competence in this area.
The European Company Law Experts Group (ECLE) said in the same vein
In light of recent developments aimed at opening up other Member States—particularly France and Germany—to plural‑vote shares, under conditions adapted to local circumstances and the characteristics of different markets, doubts intensify both as to the very appropriateness of the European proposal and its genuine added value in terms of making Europe more attractive as a listing venue, as well as the legitimacy of this Union interference in national corporate governance. If its main objective is to enhance the attractiveness of European markets, rather than to reduce intra‑European regulatory arbitrage, the proposal should be reconsidered in light of the effects it produces and its drawbacks vis‑à‑vis the process of progressive opening that is already underway.
In reality, the authors of the Directive seem caught in a dilemma. Either the Directive merely introduces a new freedom in those Member States that have so far prohibited it, leaving them free to determine the conditions for the use of MVSS, in which case its added value is practically nil given the current situation and ongoing national developments; or the Directive primarily seeks to impose mandatory minimum safeguards on companies adopting MVSS, thereby becoming a factor of rigidity and constraint within the Union, far removed from its original objective and from entrepreneurs’ expectations. In the latter case, the proposal’s main merit would lie exclusively in its very existence, insofar as the more reluctant Member States might interpret it as an additional—if not decisive—step towards accepting the inevitability of authorising a mechanism that, in just a few years, has become an essential feature of modern markets worldwide. If so, the Directive would have exhausted its practical usefulness even before its enactment.
The work by Hopt and Klauss is purely descriptive, but they welcome the Directive and its requirements, even though they would have liked them to be stricter. They also discuss whether plural‑vote shares might contravene EU primary law—which is absurd, as it equates voting or veto privileges granted to States or public authorities with contractual arrangements freely agreed by private parties when incorporating a public limited company.
It is surprising to read something like this (p. 34):
Despite the number of good reasons that may justify authorising plural‑vote shares, they may also produce negative effects and entail risks. The disciplining force of the IPO market does not appear sufficient to ensure optimal corporate governance where plural voting rights exist. Therefore, for the legislator, the most likely and reasonable option will tend to be to authorise plural‑vote structures as a general matter, but subject to limits and safeguards in favour of other shareholders in listed companies. The fact that no reliable empirical results exist as to whether such restrictions and safeguards actually fulfil their purpose, and that some authors harbour fundamental doubts about their usefulness, does not undermine this conclusion.
Despite the good reasons that may justify authorising plural‑vote shares, they may also produce negative effects and entail risks. Although the IPO market may reflect, to some extent through pricing, the presence of certain statutory clauses, that market discipline does not seem sufficient to ensure that companies adopt a socially optimal corporate‑governance configuration at the time of listing. It does not follow, however, that it is automatically justified to restrict contractual freedom through limits and safeguards in listed companies: such intervention requires additional justification, especially if there are no reliable empirical results on the effectiveness of those restrictions and safeguards, or if there is significant doctrinal controversy regarding their usefulness.
In any event, the Hopt-Klauss paper is worth reading because it reports other absurdities of the Directive. For example, its scope of application is so narrow—only companies listing on alternative markets (such as Madrid’s MAB)—that its practical effects are very limited. Around twenty European countries currently have an alternative stock market structurally comparable to the MAB, and the vast majority already allow or are in the process of allowing plural‑vote shares in that segment, which explains doctrinal doubts about the Directive’s real added value when it is, by default, limited to alternative markets.
Hopt and Klauss’s views are unsurprising when one compares the content of the Directive with the German Zukunftsfinanzierungsgesetz (ZuFinG), which introduced a new provision into the Stock Corporation Act shortly before the Directive was adopted. Once again, Germany appears to have imposed its conception of both the public limited company and the listed public limited company on the rest of Europe, while other countries have merely sought to make the result as optional as possible—casting doubt on the harmonising effectiveness of the new European legislation.
Finally, I would like to recall that the same European Commission refused to regulate multiple‑vote shares in 2007 because it considered that it lacked the competence to do so (see Shearman & Sterling, Proportionality between ownership and control in EU listed companies: Comparative legal study, 18 May 2007, and the 2016 study by the same firm with ECGI), but what it really rejected was extending the “one share, one vote” principle to all of Europe as a mandatory rule. And just as the Commission then lacked the power to impose that principle, it now lacks the competence to prohibit States from imposing it mandatorily on companies subject to their lex societatis.
And alas! it was the Spanish presidency that pushed the Directive through.
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