Lessons in control
for the tech IPOs
to secure second place after
in the market capitalisation stakes, few investors give a thought to
Google’s two-tier voting structure. Maybe they should. Recent
offerings of technology companies with capital structures
that leave founders with a majority of the voting stock, but a much
smaller portion of the economic value, have been decidedly mixed.
admittedly has done well. By the end of August its shares were up 138 per
cent from its IPO last year. Yet
down 52.5 per cent since its IPO, while the comparable falls at
72.0 per cent and 79.3 per cent. Could such volatility have anything to do
with the capital structures of these companies? If the arguments for
multi-tier voting and enhanced director election rights have any merit, the
answer ought to be no. Reinforcing control in this way is said to permit
companies to avoid short-term pressure to forego investment in research and
development, new products and so forth. In the media, where multi-tier
are common, the structure is also supposed to protect editorial values from
vulgar capital market pressure.
The counter argument is that restrictive control rights of this kind
encourage lax corporate governance and poor management accountability –
failures that have been all too visible recently in the
hacking scandal at
Rupert Murdoch’s News International. Who is right?
Fresh light is cast on the issue by a new study conducted by Institutional
Shareholder Services for the Investor Responsibility Research Center
Institute in the US, which looks at 114 closely controlled companies in the
S&P 1500 Composite Index*. These are defined as companies in which one
holder has at least 30 per cent of the voting shares. In terms of total
shareholder return the report shows controlled companies with multi-class
voting outperform dispersed ownership companies over one year, but
underperform over three and significantly underperform over five and 10
years. This is the opposite of what multi-class advocates would have us
believe. Controlled companies with one share, one vote structures
significantly outperform those with dispersed ownership or multi-class
voting except over one year.
On risk, the report finds that controlled companies with single class voting
show less volatility than both multi-class voting and dispersed ownership
over one, three, five and 10 years, while dispersed ownership is less
volatile than multi-class over all periods.
The report also throws up evidence that material weaknesses in internal
control and related party transactions are more likely to arise at
controlled companies than with dispersed ownership. Perhaps predictably, a
sample of institutional investors felt that controlled owners were less
responsive and less open to shareholder engagement than others.
The results markedly underline the point that control rights matter. There
is a clear hierarchy from controlled companies with single voting, down to
dispersed ownership companies and on to controlled companies with
multi-class voting at the bottom of the performance league table. This makes
sense. The best performers are those with skin in the game, operating with a
fair amount of accountability to outside shareholders. They deliver higher
returns for less risk. The worst are those with total protection from
shareholder pressure, who deliver the lowest returns for the highest risk.
Dispersed ownership delivers something in between.
This also fits with experience in continental Europe where the controlling
minority shareholder model delivers patchy results. Sometimes it works well;
at other times badly. The point is that outsiders are dependent on the
goodwill of the dominant shareholder to allow them to share in the higher
returns that stem from the tighter ownership control exercised by
management. It would be good to see a comparable piece of research in Europe
to confirm that picture.
What are the lessons from all this? One is for the regulators. The ISS
researchers found that the average level of board independence was much
higher at non-controlled companies, partly because exchange listing
standards allow controlled firms to have a majority of non-independent
directors. There is an obvious case for the listing authorities to insist on
more independent representation at multi-class companies to provide a
greater check on controlling directors.
For institutional investors the question is whether to have a policy against
backing multi-tier companies. I would argue for a presumption against them,
rather than a rigorous rule. In technology the stakes, in terms of market
value, are very high. And there are often exceptions that prove the rule.
The vital thing is to recognise that control matters.
© The Financial Times Ltd 2012