Decision Time

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After two years of debates, the reform of the Novo Mercado enters the homestretch. The 130 companies listed in the special corporate governance segments of the Brazilian Stock Exchange – BM&F (currently B3) – will have the opportunity to voice their opinions about the proposals presented. In practical terms, the companies are being called to express their views about the first major update of the regulations since the creation of the special segment, in 2001. This fact alone –a review after 16 years of lessons learned – should be sufficient for the companies to analyze the matter in detail. However, what’s at stake goes beyond a mere update of the regulations: it’s the survival of the Brazilian equity market.
The Novo Mercado was created in 2001 with the objective of providing a symmetric environment as to the perception of value and risk. In other others, it was aimed to fill in the existing gaps in our regulations that allowed the capture – unpunished in practical terms – of the company’s value by specific groups in a disproportional way to their participation in its capital. That was the reality of the Brazilian market in the 90’s. A study conducted by the fund manager Bradesco Templeton at that time showed an average control premium of 721% in M&As involving listed companies in that period. It means that the value per share paid to controlling shareholders was, on average, 8 times higher than that paid to those who invested in the stock exchange. Accordingly, the minority investments in listed shares were a game of losers. The growing perception of the fact led to a significant decrease in the number of IPOs, a scenario that marked the turn of the century.
The Novo Mercado was established with the objective of putting an end to that and reviving the premise that if one buys 1% of a company, he/she in entitled to 1% of its value. It’s an essential principle for the proper functioning of the market. The rules incorporated to the segment’s regulations, including the one share one vote principle, the full tag-alone rights, the access to the Chamber of Arbitration, and the requirement of independent members, among others, were intended to bring transparency and an equal treatment to all shareholders.
It has worked. After a period of uncertainties, the Novo Mercado has become a sine qua non condition for a company to issue shares in Brazil. The number of listed companies grew from zero to 130, in addition to the 29 companies listed in the Level 2 segment, which has many of these same characteristics.
But, since then, the market has settled, declared victory and started to focus on other matters. Over time, the homo economicus logic has led some companies less concerned about the principles that are the foundation of the segment to find and explore legal gaps that made many of the Novo Mercado’s rules become ineffective. In fact, today there are a number of cases of companies in the segment that imposed losses and frustrations on their investors. When asked about the rights they were supposed to be entitled to, minority shareholders had to deal with “well, but”responses.
Accordingly, the Novo Mercado seal has become less and less relevant. Today, if we ask investors whether they are willing to pay a premium for the segment, we are likely to get surprised with so many “no’s” – quite different from what happened 10 years ago. The goodwill has deteriorated.
And that’s the main reason why companies should analyze the matter in detail and vote in favor of the changes. We are talking about those companies that already participate in the segment, actually believe that their investors must be treated with equity and are really interested in the possibility that the Novo Mercado can represent again (or continue to represent, depending on the viewpoint): a differentiated segment that translates into higher share prices and, consequently, lower costs of capital (as part of this scenario, it’s important to emphasize that, after the creation of the Novo Mercado, it was observed a clear relation between the good evolution of listed shares and lower costs of capital for the companies in other instruments, such as debentures and IFDC’s [funds of investment in receivables]). It’s not about being a “nice guy” or about a manichaeistic bargain between companies and investors. It’s a win-win opportunity – at least for the good companies.
Since that the B3 has started to debate the matter, there were at least three rounds of public consultations. Unfortunately, many of them eventually got contaminated by such manichaeism, in which each new proposal was seen as a concession made by the companies to the investors.
We understand that this posture is a consequence of the institutional structure of our capital market. As companies did not engage in individual terms in the previous stages, most of the discussions took place in the entities’ level. And, in some of them, most members do not belong to the Novo Mercado or to the Level 2. Despite that, they were able to strongly influence on the debate, leading to a significant dilution of the proposals originally presented by the Stock Exchange.
Regardless the merits of the process, the remaining points to be approved by the companies represent the minimum necessary for the Novo Mercado to maintain some distinction and relevance. As it happens with other crucial reforms in Brazil – such as the social security or labor one – its approval does not mean that the debate around the matter is over. It will be only the first step to continue in the game. But its rejection will be fatal and have very undesirable effects in the very long term.
In 2010, the former BM&F Bovespa tried a reform that was frustrated by the low engagement of good companies. In the reactionary debate, the proposals were rejected. In the following years, we saw a growing number of problems involving companies listed in the Novo Mercado segment, with the segment’s image being increasingly hurt.
The good Brazilian companies – those that believe that the capital market is a tool for growth, funding and for the improvement of internal practices – cannot allow that the current reform has the same fate as that tried seven years ago. The proposals can be classified in two groups: those dealing with the companies’ internal governance and those dealing with the relation between the companies and their investors. We will not be focusing here on all of the points, but on some we consider that deserve a deeper analysis.
In the first group, we can include topics such as the redefinition of the independence concept, the minimum requirement of 2 independent members in the board of directors, the installation of the Audit Committee and the compulsory requirement of the internal audit and compliance areas.
Most of these topics have already been or are being analyzed by the companies that are concerned about their governance. In fact, it’s not acceptable that the companies listed in our market’s premium segment do not adopt these practices. It’s not about imposing unnecessary costs, but to encourage the creation of minimum structures able to prevent past problems from taking place again.
The increase in the number of independent members – yet significantly below the international norms and the recommendations on the best practices – is of utmost importance to have efficient boards that effectively debate about their decisions. Two independent members can do more to improve the boards’ discussions than one lonely dissenting voice. Most of the companies listed in the Novo Mercado segment largely surpass this requirement, and the few companies that will be actually impacted are probably those in which the presence of such members are more necessary.
Yet the Audit Committee has been consolidating in the international scenario as an absolutely essential structure so that the Board of Directors is able to take well-informed decisions. Although the Statutory Committee is the best practice, the B3 was flexible enough to allow that the committee is not set forth in the companies’ bylaws. It seems unnecessary to address the importance of the internal audit and compliance areas.
As to the group related to the relationship between the company and its shareholders, highlights are the minimum quorum to delist from the Novo Mercado, the tender offer through the increase in equity interest, the maintenance of shareholders’ rights in the event of a corporate restructuring (to close the gap that allows that they are deprived of their rights), and the transparency in management compensation, among others.
In this sphere, there are some essential tools for the segment to regain its credibility. What’s the sense of paying a “premium” for a company listed in the Novo Mercado segment if it can eventually leave behind the commitment to its clauses by delisting from the segment? The current ease with which a company can delist from the segment was established when there were uncertainties about the interest of the market in its structure. Today, with 130 companies, such uncertainties are over and the commitment to the distinction brought by the Novo Mercado seal must be firm and based on the long-term perspective.  For companies that already participate and intend to continue to participate in the segment, it’s certainly more important to give credibility to their commitments than to leave the door open to disappoint investors and go unpunished. Based on the poor credibility of appraisal reports in Brazil, the only way to ensure a fair offering price to delist is through the adhesion of investors.
Likewise, the tender offer due to the increase in equity interest is necessary considering the deterioration of the tag along concept in Brazil. Since the creation of the Novo Mercado, we have been witnessing a number of “disguised” transfers of control with the objective of depriving minority shareholders of their joint sales right. Leaving aside the merits of the jurisprudence, the law has become innocuous. The tender offer due to the increase in equity interest solves this problem by establishing that investors can transfer their positions when a relevant block of shares is bought, regardless the legalese about the change in the control.  Such rule is in line with the international best practices, notably those in force in the UK market.
In addition to the above-mentioned innovations, the B3 suggests the elimination and update of a number of old requirements that have become worthless due to the evolution of regulations and the law. Such measures would lead to significant reductions in costs and bureaucratic procedures, factors that should be considered by the companies when they vote.
Accordingly, there is no rational justification for a company listed in the Novo Mercado segment that believes in the equal treatment to all shareholders and in the importance of the capital market to be contrary to the proposals. By doing that, they would be agreeing with the most outdated voices of our market, alienated from the global good corporate governance practices.
Investors have been unequivocally positioning themselves in favor of the reform. The British fund manager Aberdeen, for example, with assets of $21 billion reais under management in Brazil and a major shareholder of companies such as Renner, Vale, and Localiza, among others, has sent letters to all of the companies in the segment requesting that they analyze and vote in favor of the changes. Companies willing to be regarded as differentiated investees by investors should analyze the reasons why they should be in favor of the reform.
What about your company? What is it going to do?