Eric Posner Discusses Proposed System of 'Square Root Voting' for Corporate Governance

Square Root Voting: A New Approach to Regulation of Chaebol, Keiretsu, and Other Conglomerate Organizations in Asia
Eric Posner, E. Glen Weyl and Sang-Seung Yi
The CLS Blue Sky Blog
July 24, 2013

The economies of several important Asian countries are dominated by large business groups. Many of them are family controlled, such as those in South Korea (known as “chaebol”), Israel and India. Others are not, the most notable example of which is the keiretsu of Japan. Whether family controlled or not, these business groups use highly complex webs of cross shareholdings and pyramidal structures to fend off hostile takeovers. Some American academics see them as an attractive model of corporate governance, but locals view them with concern. For example, the Korean families who control the chaebol through a tangled set of institutional relationships are criticized for exercising dominant voting power vastly out of proportion to the size of their economic stake. Other shareholders can thus exert little control over the chaebol, which have outsized political influence.

The recently elected president of South Korea, Park Geun-hye, ran on a platform that included an Economic Democracy agenda that took aim at the chaebol. The Park administration has proposed measures to prohibit new circular shareholding, tighten restrictions on voting rights of shares held by financial affiliates, mandate cumulative voting, and limit the rights of the families in the election of outside directors. The goal of these measures is to reduce the power of the families that control the chaebol.

The chaebol counter that restrictions on equity investments and voting rights by affiliates would force them to use corporate funds for defending against hostile takeovers instead of deploying them for productive purposes such as R&D. They further argue that the true beneficiaries of cumulative voting would be other large (typically foreign) holders, not true small Korean shareholders. The debate mirrors the arguments in the United States about poison pills—voting rules that managers insert in corporate charters that deter hostile takeovers. In both cases, the question is whether restrictions on the ability of management to minimize the influence of outside investors enhance the value of the firm (by eliminating destructive takeover battles) or reduce it (by entrenching management).

Eric Posner