Companies that broker in “disruptive technology” are increasingly testing the limits of how much they can disrupt traditional shareholder arrangements.
It is a problem that new SEC Commissioner Robert Jackson wats to tackle. He is urging exchanges to consider taking steps to prohibit companies with dual-class structures from listing securities if their shareholder structures do not include sunset provisions.
The pitch came during Jackson’s first public remarks since joining the Securities and Exchange Commission, at an event Held at the University of California’s Berkley campus on Feb. 15.
In 2017, 19 percent of U.S. companies that went public on U.S. exchanges had dual-class structures with unequal voting rights, according to the Council for Institutional Investors.
The debate over dual-class shares gained increased attention in March when is Snap Inc., the parent company of Snapchat, a photo and video-sharing app, launched a $3.9-billion initial public offering. Only non-voting shares in the company were offered to investors.
Dual class voting typically involves capitalization structures that contain two or more classes of shares—one of which has significantly more voting power than the other.
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.
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, however, are not always enough to sway proponents of the traditional “one vote/one share” approach that equates control with monetary investment. Jackson’s proposal is to find a middle ground for both corporate governance philosophies.
“There is reason to think that, at least for a defined period of time early in a company’s life, dual-class can be beneficial,” he said. “The structure can allow entrepreneurs to build for the long term—and even transform entire industries—without being subject to short-term pressure. When many managers are at the mercy of daily stock-market pressure, dual-class can help America’s most innovative companies create the sustainable long-term value we need to grow our economy.”
Many have argued forcefully, however, that one-share, one-vote should be the rule for all public corporations.
“Whatever the benefits may be of permitting dual-class in a few well-known cases, these advocates argue, the costs for investors—who are left with no way to hold management’s feet to the fire while dual-class is in place—outweigh those benefits.”
The question, Jackson asked, is not whether dual-class ownership is always good or bad. “It’s whether dual-class structures, once adopted, should last forever?”
Nearly half of the companies who went public with dual-class over the last 15 years gave corporate insiders outsized voting rights in perpetuity. “Those companies are asking shareholders to trust management’s business judgment—not just for five years, or 10 years, or even 50 years. Forever,” he said “So perpetual dual-class ownership—forever shares—don’t just ask investors to trust a visionary founder. It asks them to trust that founder’s kids. And their kids’ kids. And their grandkid’s kids. (Some of whom may, or may not, be visionaries.) It raises the prospect that control over our public companies, and ultimately of Main Street’s retirement savings, will be forever held by a small, elite group of corporate insiders—who will pass that power down to their heirs.”
It’s not just that perpetual dual-class stock ownership is disconcerting in principle. The data suggest that it is troubling in practice, Jackson said of some initial research by Commission staff.
They took a close look at 157 dual-class IPOs that have occurred over the past 15 years. They immediately noticed some pretty significant differences between the 71 dual-class companies with sunset provisions and the 86 who gave insiders control forever. Regression models predicted relatively similar valuations at their IPO dates, a trend that continued for two years after the IPO. Over time, their predicted valuations diverged:
Seven or more years out from their IPOs, firms with perpetual dual-class stock trade at a significant discount to those with sunset provisions, Jackson said. Among the small subset of firms that decided to drop their dual-class structures later in their life cycles, those decisions were associated with a significant increase in valuations.
“I’m not the only one concerned about dual-class stock and its effects on our markets,” Jackson said. Three major providers have moved to exclude dual-class companies from significant stock indexes. FTSE Russell will exclude all companies whose free float constitutes less than 5 percent of total voting power; S&P Dow Jones will, going forward, exclude all dual-class firms; and MSCI will reduce the weight that dual-class firms occupy in its indexes.
Jackson, however, feared banning all dual-class companies from major indices because “Main Street investors may lose out on the chance to be a part of the growth of our most innovative companies.”
“The next Google or the next Facebook will deliver spectacular returns, but average Americans will, quite literally, not be invested in their growth,” he said. “No one in Silicon Valley should want to leave average Americans out of their growth story.”
“That’s why I hope that our national securities exchanges will soon consider proposed listing standards addressing the use of perpetual dual-class stock,” Jackson said. “Such standards would allow Main Street investors to share in our economy’s growth—but avoid asking them to trust corporate management forever. Companies would still be able to IPO with dual-class voting arrangements—but only if management is willing to someday give shareholders their say.”
The exact form that exchange standards might take—and the best way to “sunset,” or limit, dual-class structures—is a topic Jackson plans to explore as Commissioner.
His commentary was applauded by the Council of Institutional Investors.
“We applaud Commissioner Jackson for using his first major public speech to support CII’s ongoing efforts to address the problem of unequal voting rights,” said CII Executive Director Ken Bertsch. “A dual-class structure without a sunset provision—‘forever shares’—says to investors, ‘we’ll take your money, but we won’t ever value your vote on how we use your capital to run the business over the long-term.’ That’s not equitable treatment of investors, and it’s certainly not good corporate governance.”
“We are encouraged by the call for long-overdue improvements to stock exchange listing standards to place limits on the use of dual-class stock structures,” he added. “Perpetual dual-class share structures with unequal voting power deny shareholders the means to press for change when something goes wrong, which happens inevitably at most companies. Shareholders at such companies never have any say in electing the directors who are supposed to oversee management.”