The talk of Wall Street this month is Snap Inc., the parent company of Snapchat, a photo and video-sharing app beloved by teens and millennials. Its $3.9-billion initial public offering that went public on March 2.
While self-destructing messages are a selling point of the app, critics are lambasting the fact that long-standing corporate governance norms and traditional investor rights have also disappeared. Only non-voting shares in the company were offered to investors.
The concept of exclusively issuing non-voting shares is not unheard of. In the 1920s, the practice may not have been common, but neither was it particularly controversial. Since the 1940s, however, as exchanges improved post-Depression listing standards, no-vote stock became all but extinct. Until this month, that is, when Snap resurrected the practice.
Public shareholders of Class A common stock will have no say in the running of Snap. Co-founders Evan Spiegel, chief executive, and Bobby Murphy, chief technology officer, owned 44 percent of total outstanding shares in the company prior to the IPO. They will, however, continue to control more than 90 percent of all votes even if their ownership interest dilutes over time. Control of the company will only change once both founders either die or voluntarily give up their shares.
In many ways, Snap’s approach to corporate governance shouldn’t come as a total shock. Tech companies, in particular, have increasingly favored tiered voting structures in recent years, with dual-class and multi-class share structures built around limited public voting rights. Google/Alphabet, Alibaba, Facebook, Groupon, and LinkedIn are among the companies where the majority of company control resides with owners of superior shares granted greater voting rights than the class of publicly owned stock. In these systems, founders and pre-IPO insiders retain majority voting rights and control over director selection even as their ownership, risk, and skin in the game is spread among new shareholders.
There are several reasons why tiered voting structures, including the non-voting shares offered by Snap, are a favorite of Silicon Valley companies. Objectives in doing so include giving founders—often lauded as visionaries—greater say in how their companies are run, with the ability to be nimble and pursue long-term strategies otherwise endangered by the short-term performance demands of typical shareholders.
These reasons are not enough to sway proponents of the traditional “one vote/one share” approach that equates control with monetary investment.
Snap’s strategy was attacked by corporate governance advocates from the moment it was revealed in the prospectus and S-1 filing with the Securities and Exchange Commission. Among the most vocal of those critics is the Council of Institutional Investors.
CII is a non-profit association of pension funds, endowments, and foundations, with combined assets that exceed $3 trillion. When it was formed in 1985, the very first policy it adopted was the principle of one-share, one- vote.
“CII believes that when a company goes to the capital markets to raise money from the public, public investors are entitled to certain protections and basic rights, including a right to vote that is proportional to the size of the investor’s holdings,” it says in a policy statement. If companies have already adopted a dual-class system, it expects them “to phase it out in a timely manner through sunset provisions.”
Dual-class share structures pose greater risks to investors and make boards and insiders less accountable to shareowners, CII says, citing research alleging that companies with a dual-class stock structure often do not perform as well as companies with a single class of stock and have more stock-price volatility.
CII has also expressed “concern that stock exchanges are intensifying efforts to woo companies that seek to go public with limited accountability to outside shareholders.”
“From U.S. markets to Asian exchanges, dual-class share structures, which concentrate voting power in the hands of corporate insiders, are making gains at the expense of public company shareholders,” it said in a recent statement. A proposal by the Hong Kong Exchange to permit dual-class listed companies was rejected by its regulator in 2015, but HKE CEO Charles Li recently suggested revisiting the idea.
Perhaps aiding that reconsideration, in February the Singapore Exchange (SGX) launched a consultation on permitting companies with dual-class shares to list on the exchange.
“A dual-class race to the bottom is accelerating, and investors in public companies should be concerned. Institutional investors generally oppose differential share structures with unequal voting power because they deny shareholders a means to hold management accountable if the company stumbles.”
Ken Bertsch, Executive Director, Council of Institutional Investors
“A dual-class race to the bottom is accelerating, and investors in public companies should be concerned,” says Ken Bertsch, CII’s executive director. “Institutional investors generally oppose differential share structures with unequal voting power because they deny shareholders a means to hold management accountable if the company stumbles.”
A recent letter, co-signed by 18 CII members and other institutional investors, urged Snap (pre-IPO) to reconsider its proposed governance structure go to market with a single-class voting structure.
Among those signing the letter were Aberdeen Asset Management, the California Public Employees Retirement System, CtW Investment Group, the Teamsters, and the New York City Comptroller on behalf of the New York City Pension Funds.
“The performance record of dual-class companies is decidedly mixed in the long run and even in the medium term … Some companies lacking effective accountability to owners do soar for a time, but others crash and burn, and still others pursue mistaken strategies for far too long,” the letter said. “Companies with a large disconnect between ownership and control, such as Groupon and Zynga, have stumbled relatively quickly and without effective correction mechanisms, while those like Viacom have encountered long-term challenges where insiders are entrenched.”
CII and other advocates were not just asking politely. Post-IPO, they stepped up efforts to pressure index providers and U.S. stock exchanges to revisit rules for dual-class share listings.
CII will renew its 2012 request to the NYSE and Nasdaq to bar listings of companies with multiple share classes with unequal voting rights. At a minimum, it wants exchanges to set standards for regulating these companies, with, for example, reasonable sunset provisions for multiple share classes.
SNAP’S CAPITAL STRUCTURE
The following is from Snap’s S-1 filing with the Securities and Exchange Commission.
We have three classes of common stock: Class A, Class B, and Class C. Holders of our Class A common stock—the only class of stock being sold in this offering—are entitled to no vote on matters submitted to our stockholders. Holders of our Class B common stock are entitled to one vote per share. And holders of Class C common stock are entitled to ten votes per share.
Holders of shares of Class B common stock and Class C common stock will vote together as a single class on all matters (including the election of directors) submitted to a vote of stockholders.
As a result of the Class C common stock that they hold, Evan Spiegel, our co-founder and Chief Executive Officer, and Robert Murphy, our co-founder and Chief Technology Officer, will be able to exercise voting rights with respect to an aggregate of [the exact number was left blank pending the IPO] shares of Class C common stock, which will represent approximately [89 percent] of the voting power of our outstanding capital stock immediately following this offering.
As a result, Mr. Spiegel and Mr. Murphy, and potentially either one of them alone, have the ability to control the outcome of all matters submitted to our stockholders for approval, including the election, removal, and replacement of directors and any merger, consolidation, or sale of all or substantially all of our assets.
If Mr. Spiegel’s or Mr. Murphy’s employment with us is terminated, they will continue to have the ability to exercise the same significant voting power and potentially control the outcome of all matters submitted to our stockholders for approval.
Either of our co-founders’ shares of Class C common stock will automatically convert into Class B common stock, on a one-to-one basis, nine months following his death or on the date on which the number of outstanding shares of Class C common stock held by such holder represents less than 30 percent of the Class C common stock, or shares of Class C common stock, held by such holder on the closing of this offering. Should either of our co-founders’ Class C common stock be converted to Class B common stock, the remaining co-founder will be able to exercise voting control over our outstanding capital stock.
This concentrated control could delay, defer, or prevent a change of control, merger, consolidation, or sale of all or substantially all of our assets that our other stockholders support.
Conversely, this concentrated control could allow our co-founders to consummate a transaction that our other stockholders do not support. In addition, our co-founders may make long-term strategic investment decisions and take risks that may not be successful and may seriously harm our business.
Although other U.S.-based companies have publicly traded classes of non-voting stock, to our knowledge, no other company has completed an initial public offering of non-voting stock on a U.S. stock exchange. We cannot predict whether this structure and the concentrated control it affords Mr. Spiegel and Mr. Murphy will result in a lower trading price or greater fluctuations in the trading price of our Class A common stock as compared to the trading price if the Class A common stock had voting rights. Nor can we predict whether this structure will result in adverse publicity or other adverse consequences. For a discussion regarding the rights, preferences, and privileges of our common stock, see “Description of Capital Stock.”
We do not intend to take advantage of the “controlled company” exemption to the corporate governance rules for NYSE-listed companies.
Michael Lynton, chairman of Snap’s board, responded to CII’s demands in a letter sent prior to the recent IPO. “Our founders are substantial holders of our capital stock, who even before the IPO have almost 90 percent of the voting control of the company. Our board concluded that it would benefit our stockholders to extend this control beyond the IPO,” he wrote.
Lynton directed CII to Snap’s registration statement for more information on its voting structure. “We believe that a significant portion of our success thus far has been attributable to our founders’ leadership, creative vision, and management abilities,” it says.
“It is worth nothing that, although we could have opted to be a ‘controlled company’ under the NYSE rules thanks to our founders’ voting control, our board elected to forgo that option,” he added. “That is important because it means that our board must have a majority of independent directors and both our compensation and nominating and corporate governance committees must be fully independent.”
The debate over Snap’s governance structure, and the more general topic of unequal voting rights of common stock, was addressed at a March 9 meeting of the Securities and Exchange Commission’s Investor Advisory Committee.
Among the speakers was David Berger, a partner at law firms Wilson Sonsini Goodrich & Rosati. He has more than 25 years of experience advising Silicon Valley companies on corporate governance issues (but no connection to Snap or its IPO).
There is a general perception that “Silicon Valley” and “good corporate governance” create an oxymoron when placed side by side, he said, adding that the belief is not necessarily a valid one.
Successful tech companies must contend with what Berger referred to as the “corporate governance misalignment that now exists in our capital markets today.” The governance focus is almost exclusively on the needs of stockholders and short-term objectives due to a marketplace dominated by institutional investors and stock ownership by mutual funds and ETFs rather than individual stocks.
“We have reached a point where virtually all debates on corporate governance begin and end with what is best for the public equity owners,” he said. Some companies, however, seek to be measured by more than their stock price and “consider structures so that boards can adopt longer-term strategies, including sharing some corporate profits more broadly with employees and other constituencies.”
Companies without one-share/one-vote governance structures account for nearly 12 percent of the S&P 500, said Rakhi Kumar, a managing director at State Street Global Advisors and head of ESG investments and asset stewardship.
She stressed “the importance of equal voting rights to shareholders as a mechanism that enables us to monitor and oversee our investments.”
“We focus on electing strong, independent, effective boards,” she added. “Without voting boards proportional to economic interest, our ability to elect directors that represent the interests of all shareholders is limited and we are left vulnerable to controlling shareholders.”
Beyond tech companies, media companies have often used dual-class stock to protect journalistic integrity, says Jill Fisch, a Perry Golkin Professor of Law at the University of Pennsylvania Law School.
“Snap doesn’t have a very compelling transition plan,” she said. “If one of the founders dies, the other gets voting control. If they both die, ok, that’s the end of the super control structure. But there isn’t a sunset provision. There isn’t a stated time frame that gives the founders time to recognize their objectives and take some greater risks. There isn’t any end to that in Snap’s governance documents.”
Fisch pointed out that master limited partnerships, private issuers with publicly traded debt, and preferred stock are other capital formation strategies that come very close to non-voting shares. “There are a number of ways in which issuers can access the public capital markets without giving public investors voting rights and control,” she said.
Fisch, however, isn’t buying “the idea that, somehow, shareholders have gotten too powerful and companies need to take this step to protect themselves.”
“The demands of public shareholders using voting rights have forced companies to pay attention to a variety of issues,” she said. “We have a great deal more focus on executive compensation and sustainability objectives [as a result]. Shareholders are using their voice to achieve a wide variety of social goals.”
Those voices and objectives, she added, are catalysts for positive and, ultimately, profitable corporate strategies. The track record for dual-class shares intended to isolate founders, however, “has been mixed at best.”