Alas, poor auric.

Governments often use golden shares as a method of retaining control in a privatised company of strategic importance, but is there a better way to protect national interests? Nasser Al-Shafi, Harry Churchill and John Pointon believe the approach is unnecessarily restrictive

The original idea of the golden share was to preserve the rights of the senior members of a family business by limiting the potential for recklessness by future generations, who might, be tempted to sell the family's assets for a quick buck. But it has since become a device that enables governments to act on behalf of the national interest--regardless of how the national interest might be defined.

According to the August 2002 issue of The Dealer's Journal, the UK government held golden shares in 26 companies, including Eurotunnel, National Air Traffic Services and the National Grid. It also held them in major defence contractors, such Rolls-Royce Aero Engines and BAE Systems, and many of the privatised utilities.

The concept has now spread throughout the EU, although the governments of France, Spain and Portugal have all recently had their golden share arrangements challenged in court. The main aim has been to protect key industries from foreign takeovers. In every case, governments claim to have a need for a "special rights" share written into the articles of association of the company, which prevents ordinary shareholders from exercising their full voting rights when a takeover deal arises.

Some people argue that takeovers and mergers can damage economic efficiency, because they reduce competition and consumer choice, but there are even stronger arguments which suggest that to limit the capacity for takeovers in this way reduces the incentive for managers to achieve good financial performance and enhance shareholder value.

The absence of the golden share permits: * greater "allocative efficiency", which may result from the transfer of ownership (econonmics of scale); * managerial accountability to the shareholders' interests; * the marketability of the shares themselves (special shares inhibit buyers, because they can't exercise their full voting rights).

In essence, the golden share is a special preference share, with a zero dividend, carrying the same power as that of a shareholder owning 15 per cent of the equity. Under stock exchange rules, any 15 per cent shareholder would be able to veto a takeover, because such a deal would require the articles of association to be rewritten.

A number of similar ploys have been used to prevent ordinary shareholders from exercising their full voting rights at AGMs. These include "poison pill" defences, ownership ceilings (British Aerospace), proxy voting and dual voting structures. All of these practices stand in the way of a takeover code that guarantees equal treatment for all shareholders.

The case of BT's failed attempt to merge with MCI Communications Corporation of America in 1997 illustrates how the golden share affects the equity rights of ordinary shareholders. This happened to be a lucky outcome for BT, since the resulting acquisition would have burdened the company with a mountain of debt at a time when share prices in the telecoms sector were about to nosedive. Nevertheless, the existence of the golden share was the main factor in preventing what could have been a chance for rationalisation in the global telecoms market and for British BT shareholders to access the US market. The government relinquished its golden share in BT soon after the deal failed.

Two major British defence contractors, Rolls-Royce and BAE Systems, have faced government restrictions on their freedom to merge with US partners. Rolls-Royce's ordinary shareholders would have benefited hugely from a tie-up with Pratt & Whitney, America's major aero-engine manufacturer. The deal would also have given Rolls-Royce products greater access to both the civil and military markets in a larger economy. While an argument can be made for strategic isolation in the defence industry, R&D is becoming so costly in this area that few countries will be self-sufficient in the production of armaments (see "Costing a bomb," FM May). Some amalgamation will be necessary in the future.

Another example of state intervention in the freedom of equity markets came when the British government exercised the limitation rule in the golden share it held in British Petroleum. The Kuwaiti Investment Office (KIO) acquired a large number of shares in the privatised company when the British government sold off its minority holding in 1987. The KIO was required under the rule to divest itself of the bulk of the shares, which signalled that the market for BP equity was not a free one and led to reciprocal restrictions elsewhere.

Golden shares are seen by those who seek greater liberalisation of capital markets as contrary to the spirit of free trade under the rules of the World Trade Organisation. The European Court of Justice is empowered to promote freedom of capital movement between member states, and has passed down judgments largely against the imposition of golden shares in principle. But, as with all judgments, they have had to account for special national interests in some cases, so preserving the right of governments to inhibit foreign ownership of certain national assets. This has usually meant items such as land, roads, bridges and tunnels, but the entire range of omissions has yet to be tested.

From the investors' standpoint, a company that sells shares in its business grants rights to the shareholders to vote on all the policy issues for which they have ultimate responsibility. The directors of the company are appointed by the shareholders to fulfill those policy objectives. Although it's often technically impossible to obtain a majority for a policy initiative, shareholders are able to exercise the option to sell their shares. If there is any impediment to that sale, the rights of the shareholders are reduced. It's therefore in their interests that golden shares should not be inserted in to private companies.

From a governmental viewpoint, many of the recently privatised monopolies are seen to be prime strategic public assets. In this sense, the national interest is best served politically if some inhibiting conditions are attached to the sale of these assets to private investors.

In the past, takeovers and mergers have not always been popular with customers or indeed employees, because multinational companies can be particularly fickle in their attachment to any national economy. They are often only too willing to relocate their factories to countries where the labour is cheaper or to concentrate production in their country of origin, thereby closing down enterprises that would have have been viable if they had remained independent.

Although the golden share has been seen as a potent instrument for the regulation of capital transfer, it is something of a blunt instrument and has provoked challenges in competition courts around the world. Many of the claimed advantages could be achieved by other methods, such as mutualisation or trusts, without infringing the traditional rights of ordinary shareholders. Investors make a financial commitment through shareholding and encounter the rewards and risks accordingly. They should be free to exercise all the options provided by a common shareholder code in all cases. Governments that sell companies to shareholders for cash should not expect to have the cash and the control.

Nasser Al-Shafi is a financial analyst for the Supreme Council for Economics Affairs and Investment, Qatar. Harry Churchill is senior lecturer in economics at the University of Plymouth, where John Pointon is professor of finance.