3.4.0 Introduction

Arbitrage is a crucial mechanism of market efficiency because its effect is to bring prices to fundamental values.1 This section shows that arbitrage can similarly improve voting efficiency. Even if the initial distribution of information, skills, and preferences among shareholders is such that a majority of the shares risks being voted in favor of the incorrect option, arbitrage can reallocate voting power into the hands of shareholders with superior information and skills and with appropriate incentives. In this way, arbitrage increases the probability that a majority of the shares will be voted in favor of the correct option.

To be sure, there are differences between securities arbitrage and voting arbitrage that render the analogy imperfect. Perhaps the most striking difference concerns incentives. Securities arbitrage involves the exploitation of an opportunity to profit from the mispricing of a security by making money when the price of the security returns to its fundamental value. Because of this profit potential, the securities market "creates a strong incentive for revelation of whatever information people actually hold."2 The profit potential from engaging in voting arbitrage is far less concrete. The shareholder 's reward for spending resources to promote a correct voting outcome is that ultimately he should profit from an increase in the value of the firm if the correct option is chosen. The shareholder will not capture the full increase in firm value; he can only hope to receive, through a capital gain on his shares, a pro rata share, while the other shareholders will receive their pro rata share.3

But let us put differences aside and focus on similarities: at a fundamental level, both securities arbitrage and voting arbitrage concern the removal of information asymmetry. From this perspective, there are three strategies that a shareholder with superior information about the correct option could deploy to leverage his information and increase the probability that a majority of the votes will be cast in favor of that option: (1) buying additional shares and thus voting rights, (2) soliciting proxies, and (3) buying votes without the corresponding economie rights. The limits of voting arbitrage become clear as we focus on cost constraints and legal constraints to these strategies.