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.