Shareholder democracy is ailing

2017-02-14 11:25:53

Snap s refusal to hand out any voting shares is part of a wider trend towards

corporate autocracy

Feb 11th 2017

DEMOCRACY is in decline around the world, according to Freedom House, a

think-tank. Only 45% of countries are considered free today, and their number

is slipping. Liberty is in retreat in the world of business, too. The idea that

firms should be controlled by diverse shareholders who exercise one vote per

share is increasingly viewed as redundant or even dangerous.

Consider the initial public offering (IPO) of Silicon Valley s latest

social-media star, Snap. It plans to raise $3-4bn and secure a valuation of

$20bn-25bn. The securities being sold have no voting rights, so all the power

will stay with Evan Spiegel and Bobby Murphy, its co-founders. Snap s IPO has

echoes of that of Alibaba, a Chinese internet giant. It listed itself in New

York in 2014, in the world s largest-ever IPO, raising $25bn. It is worth

$252bn today and is controlled by an opaque partnership using legal vehicles in

the Cayman Islands. Its ordinary shareholders are supine.

Optimists may dismiss the two IPOs as isolated events, but there is a deeper

trend towards autocracy. Eight of the world s 20 most valuable firms are not

controlled by outside shareholders. They include Samsung, Berkshire Hathaway,

ICBC (a Chinese bank) and Google. Available figures show that about 30% of the

aggregate value of the world s stockmarkets is governed undemocratically,

because voting rights are curtailed, because core shareholders have de facto

control, or because the shares belong to passively managed funds that have

little incentive to vote.

Cheerleaders for corporate governance, particularly in America, often paint a

rosy picture. They point out that fewer bosses are keeping control through

legal skulduggery, such as poison pills that prevent takeovers. Unfortunately,

these gains have been overwhelmed by three bigger trends. The first is that

technology firms can dictate terms to infatuated investors. Young and with a

limited need for outside capital, many have come of age when growth is scarce.

Google floated in 2004 with a dual voting structure expressly designed to

ensure that outside investors would have little ability to influence its

strategic decisions . Facebook listed in 2012 with a similar structure and in

2016 said that it would issue new non-voting shares. Alibaba listed in New York

after Hong Kong s stock exchange refused to countenance its peculiar

arrangements. Undaunted, American investors piled in.

At the same time there has been a drift away from the model of dispersed

ownership in emerging economies, with 60% of the typical bourse being closely

held by families or governments, up from 50% before the global financial

crisis, according to the IMF. One reason has been lots of IPOs of state-backed

firms in which the relevant government retains a controlling stake. Hank

Paulson, a former boss of Goldman Sachs, helped design many of China s

privatisations in the early 2000s. The Chinese could not surrender control,

his memoirs recall. Mr Paulson hoped that the government would eventually take

a back seat, but that has not happened. Other emerging economies, including

Brazil and Russia, copied the Chinese strategy of partial privatisation. And

across the emerging world, tightly held family firms, such as Tata in India and

Samsung in South Korea, are bigger than ever.

Voter apathy is the third trend, owing to the rise of low-cost index funds that

track the market. Passive funds offer a good deal for savers, but their lean

overheads mean that they don t have the skills or resources to involve

themselves in lots of firms affairs. Such funds now own 13% of America s

stockmarket, up from 9% in 2013, and are growing fast. A slug of the

shareholder register of most listed firms is now comprised of professional

snoozers.

For many in business the decay of shareholder democracy is irrelevant. After

all, they argue, investors own lots of other securities bonds, options, swaps

and warrants that don t have any voting rights and it doesn t seem to matter.

At well-run firms such as Berkshire, shares with different voting rights trade

at similar prices, suggesting those rights are not worth much. Some managers go

further and argue that less shareholder democracy is good, because voters are

myopic. Last year Mark Zuckerberg, Facebook s boss, pointed out that with a

normal structure the firm would have been forced to sell out to Yahoo in 2006.

It doesn t take a billionaire to poke holes in this logic. For economies,

toothless shareholders are damaging. In China and Japan firms allocate capital

badly because they are not answerable to outside owners, and earn returns on

equity of 8-9%. A study in 2016 by Sanford C. Bernstein, a research firm, got

Wall Street s attention by calling passive investing the silent road to

serfdom . Without active ownership, it said, capitalism would break down.

Democratic deficit

At the firm level, voting rights are critical during takeovers, or if

performance slips. At Viacom, a media firm with dual-class shares, which ran

MTV in its heyday but which has stagnated for the past decade, outside

investors are helpless. Control sits with the patriarch, Sumner Redstone, aged

93, who has 80% of its votes but only 10% of its shares. Yahoo (once as sexy as

Snap) has lost its way, too. But because it has only one class of shares,

outsider investors have been able to step in and, using their voting power,

force the firm to break itself up and return cash to its owners.

The system may be partially self-correcting. Some passive managers, such as

BlackRock, are stepping up their engagement with companies. If index funds get

too big, shares will be mispriced, creating opportunities for active managers.

If shares without votes are sold for inflated prices, their owners will

eventually be burned, and won t buy them again. And if fashionable young firms

miss targets, they will need more cash and will get it on worse terms. But in

the end shareholder democracy depends on investors asserting their right to

vote in return for providing capital to risky firms. If they don t bother,

shareholder democracy will continue to decline. That is something to think

about as fund managers queue up for Snap s IPO.