The need to regulate cross-shareholdings in the Philippines
By Euney Marie Mata-Perez on June 8,2023
THE structure of a company’s ownership and control greatly influences its corporate governance. Thus, the success of a company’s corporate governance is also determined by its permitted shareholding structure.
A question that should then be addressed by our Securities and Exchange Commission (SEC) is whether cross-shareholdings should be permitted or at the very least, regulated.There is no provision of law or regulation in the Philippines which prohibits two or more companies from holding shares in each other, or so-called cross-shareholding or reciprocal shareholding. Thus, a subsidiary can acquire and hold shares of its parent company, and be able to exercise all rights of a shareholder in its parent company just like any other shareholder.Not being prohibited, cross-shareholdings are present in many Philippine companies, including listed companies. However, there have been calls for the SEC to regulate or restrict cross-shareholding, and such calls are for valid reasons.Cross-shareholding could add “artificial power” because of more votes in favor of majority shareholders, and thus prejudice the minority. In simple terms, cross-shareholdings between parent and subsidiary companies allow subsidiaries to vote its shares in the parent, resulting in additional votes which are controlled by the parent company’s majority shareholders.This “additional control” definitely results in the majority shareholders being able to wield more power and control, since “control” or voting in the corporate world is dictated by numbers — the number of voting shares held by stockholders. This additional power could result in majority shareholders being able to make self-serving decisions or actions that may not be aligned with the interests of minority shareholders. As one author said, “cross-holders have historically been rock-solid voters in line with management, [and thus] they provide undeserved comfort to executives that consistently underperform or ignore shareholders.”Also, a complex or circular structure of shareholdings between parent companies and their subsidiaries could also obscure the true ownership of the companies, thus making the locus of control in companies less transparent.It is thus of no coincidence that the Organization for Economic Cooperation and Development (OECD) espoused that it is good practice to regulate corporate group structures. Specifically, the OECD recommends that authorities consider setting out requirements that limit certain structures of company groups such as cross-shareholdings or having safeguards to protect minority shareholders’ interest against risks arising from certain group structuresAccording to the OECD, cross-shareholding often concerns investors, as it may reinforce the status quo and suppress changes in the management. Furthermore, the cross-shareholding may reduce incentives for the management to respect minority shareholders’ interests and fulfill their accountability with respect to corporate governance.The World Bank also includes as a Measure of Quality for Minority Investors in its Doing Business Report this question indicating best practices ― “Is a subsidiary prohibited from acquiring shares issued by its parent company?” For the Philippines, the answer to this question is obviously a no.It may be stressed that a “cross-shareholding” between a parent and a subsidiary is just one of the ways that a company shareholding group can be structured. Group structuring can include layering, pyramidal structures, circular-shareholding and block holdings. These group structures can result in combinations of complicated ownership relations, which may make control of the listed company very opaque and may increase the risk of abusive use of the group structure.Thus, in many jurisdictions, like in the United Kingdom, cross-shareholding is restricted or regulated, or even prohibited. In 2018, Japan introduced revisions to its corporate governance code, which obliged companies to provide justification for cross-shareholdings and required them to propose plans to unwind them, a measure which shook up their corporate world.And there are other issues in cross-shareholding.Cross-holdings can lead to double-counting, whereby the equity of each company is counted twice when determining value, which can result in estimating the wrong value of the two companies. Such double counting of equities would obviously render a company’s valuation inaccurate.Cross-holdings are often viewed to result in an inefficient use of capital — that the capital invested in another company’s stock could be more effectively used if directly invested in expanding the core business of the cross-holding company.In the event of a major recession or another economic downturn, the practice of cross-holding is likely to create a domino effect, where the financial failure of one company could lead to the financial failure of other companies that own significant cross-holdings of the first company’s stock.In other words, cross-shareholding has been to act as vaults of shareholder equity, locking it away from places it could be deployed with higher returns or, worse, creating balance sheet volatility when the market spasms.Proponents of cross-shareholding can, of course, cite some advantages, like bringing better synergies and collaborations between companies. However, these advantages can just be cited to mask underlying motives to perpetuate control which are inconsistent with good governance and inimical to minority shareholders’ interests.It is just high time that our SEC follows the worldwide trend of good governance and regulates cross-shareholding.
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Euney Marie J. Mata-Perez is a CPA-Lawyer and the managing partner of Mata-Perez, Tamayo & Francisco (MTF Counsel).