Letter number 1 of December 2004
- QUESTIONS & COMMENTS
An EU regulation (1) dated 8 October 2001 defines the status of an SE. A Council Directive (2), also dated 8 October 2001, provides more details on employee involvement.
The Regulation entered into force on 8 October 2004. However, its provisions will only be applicable in a member state as of the date on which that member state transposes the EU Directive on Worker Involvement into domestic law, and adapts its domestic law to fit with the SE, on points which are not covered by the Regulation or on those for which member states have an option. Only 9 out of 28 EU and EEA members (Austria, Belgium, Denmark, Finland, Hungary, Iceland, Malta, Sweden and the UK) have already done what is required, although the UK and Luxemburg and the Netherlands are poised to do so soon.
A listed Austrian company (Bauholding Strabagis), a Finnish one (Elcoteq) and two private Dutch companies have already transformed themselves into SEs. The largest Scandinavian banking group, Nordea, has announced its intention to do so in the not-too-distant future.
Why create a European company? The aim behind the SE is to get rid of the legal, financial and practical constraints that are the result of 25 different legal systems, which hamper companies seeking to organise their business on an EU level. It will enable companies to cut administrative costs by reducing the number of companies that need to be set up to do business. The SE will result in a more fluid decision-making process.
The SE will make it possible to set up a company that is not Swedish German or Italian, etc., but “European”. The SE will be a ready-made tool that will make it much easier for companies to carry out cross-border mergers, which are currently virtually impossible, given the distortions and incompatibility of legislation applicable in the different member states. What happens is that companies seeking to merge have to make takeover bids or asset contributions, or set up other complicated structures such as dual listing (Reed Elsevier, Shell).
For example, an Italian group could avoid launching a takeover of a Spanish group by simply merging with the latter, thus creating a company which would be neither Italian nor Spanish, but European. Moreover, the merger would not normally be perceived by the Spanish market as an Italian company seizing control of a Spanish asset, as a takeover bid might be.
How is a European company created? Technically, there are four ways of setting up an SE – by way of a merger, through the creation of a holding company, in the form of a joint subsidiary and by the transformation of a company organised under the laws of a member state (with activities in at least two member states).
Without providing an in-depth analysis of how the SE works, below we set out the main technical aspects involved in setting one up:
Registered Office: even though the SE is above all a European company, its registered office must be located in only one of the member states of the EU. The choice of location of the registered office is important, as it will determine which laws will apply to the points that are not covered by EU laws (especially company law). This point should not be overlooked – even though the company is European, it will still be covered by the domestic laws of the country in which it has its registered office, for points that are not covered by European regulations.
In addition, the registered office must be located in the member state where the company has its central administration, i.e. its operational headquarters. The registered office can be transferred to another member state without the company being dissolved or a new legal entity being set up, on condition that the operational headquarters are transferred as well.
Corporate Governance: the SE can have a dual system of corporate governance, with a board of directors and a supervisory board, or the standard system with a board of directors. The dual system is standard in Germany, but non-existent in Belgium; in France, this option already exists.
Worker involvement: provision has been made to involve workers at a supervisory level and also in developing company strategy. Member states can choose between a number of different worker involvement models for transposition into domestic law:
- Worker presence on supervisory board or board of directors,
- Worker presence on separate staff representative body within the SE,
- Any other model that is set up by contract.
Share capital: The SE should have a share capital of a minimum of €120,000, which should not act as a barrier to groups large enough to want to expand their business on a European scale.
However, it is important to remember that the establishment of an SE will have to be preceded by negotiations on worker involvement, with an organisation representing all of the staff of the participating companies. It will be impossible to set up an SE and for the SE to operate, until the issue of worker involvement has been settled.
If a satisfactory agreement cannot be reached, a set of “standard” principles will apply.
If an SE is set up as part of a merger process, the “standard” principles relating to worker involvement will automatically apply if at least 25% of workers had enjoyed a say in the decision-making process before the merger. In other words, groups located in countries with very protective labour laws (Germany), will not be able to take advantage of a merger into an SE in order to substantially reduce workers’ rights.
- Tax issues: European law relating to SE tax issues is still in the process of being defined. For example, for corporation tax, the SE will be treated like any other multinational, i.e., it will be subject to the applicable domestic tax regime and legislation, on both a company and branch level. The SE will thus remain subject to tax in all member states where it has stable establishments. Furthermore, the Directive aimed at introducing a tax regime that would be favourable to the payments of dividends, especially for SEs, is due to be transposed into national law by EU member states before 1 January 2005.
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In conclusion, although the SE would appear to be a vehicle which will make it easier for European groups to set up and manage companies, there are a number of issues that will not be settled until all member states have transposed the European regulations into domestic law. We can only hope that this will happen quickly. In theory, all draft legislation was supposed to be ready by 8 October 2004, but we’ll probably have to wait a while longer before it will be possible to set up an SE in all EU member states.
Rome wasn’t built in a day!
Many thanks to Philip Person for this article
(2) A Directive sets out a certain number of goals to be achieved. It therefore has to be transposed into domestic law by EU member states.
But how long could such an impact last, when considering that inclusion/exclusion is unlikely to significantly influence a company’s financial fundamentals, which are based on the required future return and the discounting rate (and thus risk) applied to this return. Chen, Noronha et Singal (1) have studied the short- and medium-term impact of stock additions and removals for the S&P 500 over a period stretching from 1962 to 2000.
For the period from 1962 to 1975, during which there were no official announcements on the index’s composition, the authors found that adding stocks to the S&P 500 or removing them, had no significant impact on their price performance, in either the short or medium term. From 1976 to 2000, shares newly included in the S&P 500 did get a short-term boost. An increase in the share price is both observable the day of the announcement of inclusion in the index and, increasingly, between the date of the announcement and the effective date of inclusion in the index. Moreover, this positive impact persists over a period of 60 days, and the improvement in the share’s return (6% on average) seems to have been long-lasting after inclusion in the index. During this same period, we also see a negative impact on short-term price performance of stocks removed from the S&P 500, but, interestingly, this negative impact is reabsorbed within 60 days.
Such asymmetry in medium-term impact calls seriously into question the main explanations put forward until now by financial researchers. The main explanation has been that securities are not perfectly interchangeable. According to this argument, the inclusion or exclusion of shares in an index should generate a persistent, opposite impact in each of the two cases. However, for this explanation to be valid, we would have had to have seen a negative impact in the medium term for the stocks removed from the index, which does not appear to have been the case.
Another explanation suggests that fund managers’ reworking of an indexed portfolio dried up liquidity in the stock, thus creating short-term pressure on it. This possibility is not disproved by these results, given the significant increase in trading of shares the day of the actual change in the index composition. However, it does not explain why the positive impact of a stock’s joining an index lasts so long.
The authors therefore suggest that a stock added to an index benefits from increased visibility from investors, particularly individual investors, while a removal from an index would not have a negative impact on its visibility. The assumption is that this visibility can have a sustained positive impact on a company’s performance, as:
1) it leads to increased investor vigilance of management; and
2) it gives it easier access to capital under better terms.
This assumption is supported by the considerable increase in the number of individual investors in companies newly added to the index, while exclusion from the index does not reduce this number of individual shareholders to the same extent. This argument, incidentally, is consistent with research by Barber and Odean (2), which demonstrates that the behaviour of individual investors is strongly influenced by the media spotlight. Meanwhile, Denis, McConnell, Ovtchinnikov and Yu (3) show that companies that were added to the S&P 500 from 1987 to 1999 significantly improved their operating performance after admission.
So there does appear to be a sustained impact from inclusion in a major stock index. This fact is obviously of some importance in terms of financial and strategic decisions that must be made by managers of companies likely to be added to or removed from indexes. Indeed, these results would suggest that in certain cases, there are greater incentives for managers to carry out major acquisitions that can help clear the way into an index. Inversely, a company on an index’s short list that is considering a spin-off or an asset disposal that would take it off that list should not be discouraged from doing so, under the presumption that this would have a negative impact on its long-term price performance.
(2) Barber and Odean “All that Glitters: The Effect of Attention and News on the Buying Behavior of Individual and Institutional Investors ”, Working Paper, Haas School of Business, Berkeley, 2003.
(3) Denis, McConnell, Ovtchinnikov and Yu “S&P 500 index additions and earnings expectations ”, Journal of Finance, due out.
In retrospect, what a big mistake this was! Just how big can be seen in comparing 2003 transaction volumes for these stocks:
Liquidity indeed begets liquidity, especially in this age of globalisation, and investors go where the leading market is. And for almost all European companies, the leading market is in Europe.
Is it too late to reverse course? Unfortunately, the answer is probably yes, as things currently stand.
To be sure, US delisting rules have recently been eased. It is now enough submit a board decision and then ask the SEC to suspend share registration. However, delisting is one thing and the end of obligations incurred from past SEC filings is quite another.
If the company has fewer than 300 US-domiciled shareholders, it no longer has any obligation vis-à-vis the SEC; this is how LVMH was able to leave the NASDAQ two years ago. If it has more than 300 US-domiciled shareholders, it can still claim an exception to end the financial reporting obligation, but only if, de facto, it has fewer than 300 US-domiciled shareholders (sic) …
Should companies give up all hope? No, because US market authorities are realising that the fact that it is almost impossible for a company to delist from the US when it is already listed on another market, discourages other companies from seeking a US listing. Porsche, Daiwa and Fuji Photo, for example, have cancelled their US listing plans.
Associations of European listed companies have proposed that New York-listed companies be able to end their SEC filing requirements two years after an IPO or other primary market transaction if US trading volumes amount to less than 5% of total volumes on the stock.
R. Pozen, a Harvard law professor, suggests that if an equitable cash squeeze-out offer is made to US shareholders, the company will be able to leave the US market once and for all. An independent expert would compare the cost for a US investor of transactions in the US and abroad, assess the level of information required on the company’s home market vs. the US and then measure the additional taxes that a US shareholder would have to pay on dividends paid outside the US compared with tax on dividends paid in the US prior to the squeeze-out. On this basis, the appraiser would assess whether the offer was equitable. Once this was done, the company could put an end to its suffering, regardless of whether the offer was accepted or refused by more or less 300 US-domiciled shareholders.
Yes, there is hope, Virginia!