Dominant shareholders, holding alone or in concert more than 50% of the voting power in public companies, have traditionally characterized the Israeli capital market. Consequently, Israeli corporate governance rules for public companies have focused on protecting the public of shareholders from the dominant powers of the all-controlling shareholder. These rules give the minority (non-controlling) shareholders effective voting control over the adoption of certain resolutions, including the appointment of two independent directors, the approval of transactions between the company and the controlling shareholder, and the approval of a remuneration policy.
While they are common in many public markets, Tel Aviv Stock Exchange (TASE) companies without controlling shareholders (i.e., companies with a decentralized holding structure) were initially viewed as a rare and intriguing phenomena. Recent years have seen real growth in the number of TASE companies without a dominant shareholder, a result of both sale-downs by dominant shareholders and IPOs by Israeli tech companies.
On June 20, 2022, the Knesset approved the first reading of an amendment to the Companies Law. The aim of this amendment is to strengthen corporate governance in public companies with no controlling shareholder. The proposed amendment, which prescribes a new set of rules to ensure proper management of these companies and protection of their investors, revises the corporate governance rules in companies with a decentralized holding structure.
The amendment also proposes to revise the definition of the term “control” in the Securities Law by reducing the threshold holdings rate so that any shareholder holding 25% is considered a controlling shareholder if no other shareholder holds more than 50%. Expanding the definition of “control” will reduce, in effect, the number of companies considered as a companies without a control core.
Does the amendment really provide relief to companies with no control core?
The proposed amendment eases restrictions imposed on public companies with a decentralized holding structure, since it proposes to rescind both the obligation to appoint outside directors and the prohibition on paying additional remuneration to an independent director holding office as chairman of the board.
However, the amendment also attempts to address the concern regarding “management control,” which ostensibly exists in companies with no control core. It also seeks to define procedures for proposing candidates for directors office’s, for adding a lead independent director alongside the chairman of the board (if the CEO simultaneous serves as a chairmen), and for special approvals of public companies’ transactions with shareholders holding at least 10% of the voting rights therein.
Providing relief to companies with a decentralized holding structure is a welcome change, mainly when it occurs by eliminating restrictions that were imposed in order to restrain controlling shareholders’ power. However, under the current situation, it is unclear if the addition of corporate governance rules is necessary for companies with a decentralized holding structure. There is also a real concern about “management control” that might require regulatory intervention. In our opinion, the Israeli market should adopt corporate governance practices similar to those in public companies in other markets, which rely on shareholders’ right to dismiss incumbent directors and to appoint other directors in their stead.
How do foreign markets handle companies with no control core?
On the London Stock Exchange, companies’ independence from the controlling shareholder is a major issue, and investors tend to regard dominant control cores in public companies as a threat to public shareholders. Therefore, controlling shareholders seeking to launch an IPO in London are usually required to have a board of directors with a majority of independent directors and an independent chairman. In addition, they must undertake not to wield their majority power to direct the company’s activities. Nevertheless, as is often the case in the London market, these are normative practices and not regulatory requirements.
In the US market, public companies with a strong control core are also uncommon. However, complex mechanisms have been developed in US law that enable and regulate shareholders’ intervention in public companies through general meetings to appoint directors and pass resolutions.
Unlike in the UK and the US, corporate governance provisions in Israel largely focus on addressing the “principal-agent problem” deriving from a centralized ownership structure. These provisions seek to ensure the company is managed in the best interests of all shareholders and to prevent controlling shareholders from exploiting their positions for personal gain at the expense of the company or the public shareholders.
As mentioned above, the multiplicity of companies without controlling shareholders has led to new types of problems that the local market is still trying to resolve, since, as stated, current corporate governance rules were designed mainly for companies with a controlling shareholder.
What is “management control” and what is the regulatory authority’s position?
The challenge in companies without a control core is the power the board of directors and management wield when there is no dominant controlling shareholder to oversee their activities.
However, we believe companies with no control core should not be considered as a problem which requires correction, but rather as the natural state of public companies. The Israeli market should learn from the UK and the US, where public companies function successfully with no control core using the standard tools available to shareholders, namely the power to appoint and dismiss directors.
In our assessment, in the coming years, we will see an increasing number of companies with no control core on the Tel Aviv Stock Exchange (TASE) as well. For example, most technology companies (the companies with the highest potential for joining the TASE) reach the IPO stage without having a control core from the outset. Thus, the number of companies listed on the TASE with a decentralized holding structure is likely to increase.
Make no mistake, though, Israel will always have traditional family-controlled companies with a control core.
Should we be worry of companies without a control core?
The emergence of new companies with decentralized holding structures is an essential precondition to the continued growth of Israel’s economy and capital market. While companies with a control core primarily serve controlling shareholders, with the public as a secondary player, companies without a control core offer an important additional advantage, namely shareholders’ ability to drive change. The growth potential, interest in, and volatility of companies of this type are factors that drive growth over time in the capital market. Therefore, we believe public companies should strive to increase their shareholders’ involvement in them.
What power do shareholders wield in companies without a control core?
In companies with a control core, there is an importance in taking a resolutions by a special majority, especially in matters such as voting to appoint outside directors and to approve controlling shareholder transactions. In contrast, shareholders in companies without a control core have an impact on the most important process, which is the appointment and replacement of directors. This facilitates transparent conduct, which allows for the voicing of opinions and discourse among shareholders, through position papers, open discussions, and confrontation between shareholders when passing material resolutions in the company. In this regard, the Israeli capital market is lagging behind the processes abroad in public companies with no control core.
In companies with no control core, tools enabling shareholders to receive information and influence decision-making in the company are very important. These include voting via proxy cards and proxy solicitation. Such tools are still unfamiliar to us in Israel.
As stated, the proposed amendment seeks to prescribe that in companies where no shareholder holds more than 50% of the means of control, any shareholder holding at least 25% of means of control will be deemed a controlling shareholder. Ostensibly, such a change will reduce the number of companies deemed companies with no controlling shareholder.
However, even under the current legislative situation, it is certainly possible the largest shareholder of a company who holds less than 50% will be considered a controlling shareholder for all intents and purposes. This is true at high holding ratios (approaching 50%) and is subject to interpretation at lower holding ratios (approaching 25%). It should noted that even today the rules relating to controlling shareholder transactions apply to anyone holding 25% of the voting rights in a company, when no shareholder holds more than 50% of the voting rights.
In light of this, lowering the control threshold will apply mainly to appointments of outside directors and the approval of remuneration policies in such companies. It will also eliminate the uncertainties in situations when a company’s largest shareholder has a holding ratio approaching 25%. Also keep in mind that determining control at holding ratios of between 25% and 49.9% is a rebuttable presumption.
We believe this amendment is not a necessity and that, while it eliminates uncertainties at high holding ratios, it could create undesirable situations when the aggregate holding ratios approach 25%. In this situation, the imposition of strict corporate governance rules on companies and on shareholders holding more than 25% may only be detrimental.
In our opinion, the expected continued increase in the number of public companies with decentralized holding structures is desirable and welcome. The Israeli capital market will be required to adapt to these companies by adopting rules and procedures that enable shareholders to participate in these companies’ voting processes. In addition to these tools, it is warranted to continue processes that provide relief, releasing these companies from the corporate governance rules designed for companies with controlling shareholders. This situation will generate a need for both regulation and voluntary rules and tools to be adopted by these companies. There is room to presume and hope this will be done according to the models we have seen to date in the UK and the US.
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