‘Golden shares’: the microeconomic cost Second European Corporate Governance Conference Dr Luis Correia da Silva, Director Dr Leonie Bell, Senior Consultant June 28th 2005

2 Golden shares and other special rights -grant public authorities influence on the governance of EU privatised companies -control over shareholder structure and/or management -restriction on investment in the companies -Commission proceedings and ECJ judgments -against Treaty freedoms of capital movement and establishment -considerable legal analysis, but what is the economic impact?  Oxera research for Commission

June 28th Research questions -what is the economic impact on direct investment and the market for corporate control? -barrier to cross-border investments -barrier to integrated EU financial markets, also for portfolio investment -distortion of level playing field -do golden shares affect the performance of individual companies? -takeover threat as incentive mechanism -state involvement in management decisions

June 28th Different types of golden share DiscriminatoryNon-discriminatory Direct investment restriction Caps restricting substantial blockholdings by foreign investors (Petrogal, Banco Totta & Acores …) Caps restricting substantial blockholdings (BAA, Distrigaz, Telefónica …) Authorisation or veto rights for shareholdings (Elf Aquitaine, ENI, Endesa …) Indirect investment restriction Approval or veto rights for corporate decisions (Copenhagen Airport, Telecom Italia …) Rights of appointment (Distrigaz, KPN, TNT …) Limitation of voting rights (Volkswagen, Repsol …) Note: Examples of companies are shown in brackets, and include special rights that have now been redeemed.

June 28th Relevant evidence: privatisation literature (I) -Boardman and Laurin (2000) examine share price performance of 99 international companies post privatisation -large three-year buy-and-hold returns -76% and 116% for UK electricity and water companies -more than 50% for non-UK companies and UK non-utilities -but presence of golden share has negative impact -reduces three-year buy-and-hold returns by 53–62 percentage points ‘supports the hypothesis that failure to transfer complete control to the private sector, combined with uncertainty surrounding the exercise of the golden share, has a detrimental effect on long-run share price performance’

June 28th Relevant evidence: privatisation literature (II) general performance improvements following privatisation -higher profitability (Megginson et al, 1994) -2.5 percentage points increase in average return on sales -lower debt levels, higher dividend payouts -greater long-run productivity (Ehrlich et al, 1994) -1.6–2% annual increase in average productivity growth -1.7–1.9% annual decline in costs  transfer of ownership (and control) to private sector improves financial and productivity performance

June 28th Relevant evidence: corporate control literature (I) -large takeover premiums -15–31% average in Europe during 1995–2004 (JPMorgan) -supported by academic research (eg, Goergen and Renneboog, 2003) -voting and control rights carry significant market value -shares with superior voting rights trade at a substantial premium -eg, up to 80% in Italy (Zingales, 1994) -average premiums of 2–38% for control blocks in different EU countries (Dyck and Zingales, 2002)

June 28th Relevant evidence: corporate control literature (II) -introduction of anti-takeover provisions has negative impact on performance -up to 2% reduction in share values -Jarrell and Poulsen (1989), Easterbrook and Fischel (1991), etc -1% decline in return on capital and in productivity -Bertrand and Mullainathan (2003) -further supporting evidence in Gompers et al (2003) and Mikkelson and Partch (2003), etc

June 28th Relevant evidence: market segmentation literature -restrictions on foreign shareholdings reduce market value -Bailey et al (1999), Stulz and Wasserfallen (1996), etc -restrictions on cross-border investment have adverse impact on -share valuation and performance -allocation of savings and capital across countries -integration of financial markets -etc

June 28th New empirical research: case studies -do golden shares have a negative impact on the performance of individual companies? -financial analysis of performance: profitability, share prices -assessment of operating performance: productivity, efficiency, investment -sample of privatised EU companies affected by recent infringement proceedings -historical performance assessment -performance benchmarking  establish underperformance over time and compared with companies without golden shares

June 28th New empirical research: event studies -what was the impact of the redemption of golden shares in UK electricity and water companies? -golden share restricted shareholdings to 15% or less -abolished in results show -surge in takeover activity following redemption -significant share price reactions around event dates -Oxera report due at the end of 2005

June 28th Summary and issues for discussion -golden shares have microeconomic cost -company performance, direct and portfolio investors, market integration -are the costs justified by public-interest objectives? -could these objectives be achieved by alternative control mechanisms? -eg, regulatory framework for public utilities -would governments be less willing to privatise if they did not have the option to retain direct control rights?

Contact: Dr Luis Correia da Silva ++44 (0)