From The Harvard Law School Forum on Corporate Governance and Financial Regulation:
Editor's note
Lucian Bebchuk
is the James Barr Ames Professor of Law, Economics, and Finance, and
Director of the Program on Corporate Governance, at Harvard Law School. Kobi Kastiel is the Research Director of the Project on Controlling Shareholders of the Program. This post is based on their Article, The Untenable Case for Perpetual Dual-Class Stock, forthcoming in the Virginia Law Review. The Article is part of the research undertaken by the Project on Controlling Shareholders.
We recently placed on SSRN our study, The Untenable Case for Perpetual Dual-Class Stock. The study, which will be published by the Virginia Law Review
in June 2017, analyzes the substantial costs and governance risks posed
by companies that go public with a long-term dual-class structure.
The long-standing debate on dual-class structure has focused on
whether dual-class stock is an efficient capital structure that should
be permitted at the time of initial public offering (“IPO”). By
contrast, we focus on how the passage of time since the IPO can be
expected to affect the efficiency of such a structure.
Our analysis demonstrates that the potential advantages of dual-class
structures (such as those resulting from founders’ superior leadership
skills) tend to recede, and the potential costs tend to rise, as time
passes from the IPO. Furthermore, we show that controllers have perverse
incentives to retain dual-class structures even when those structures
become inefficient over time. Accordingly, even those who believe that
dual-class structures are in many cases efficient at the time of the IPO
should recognize the substantial risk that their efficiency may decline
and disappear over time. Going forward, the debate should focus on the
permissibility of finite-term dual-class structures—that is, structures
that sunset after a fixed period of time (such as ten or fifteen years)
unless their extension is approved by shareholders unaffiliated with the
controller.
We provide a framework for designing dual-class sunsets and address
potential objections to their use. We also discuss the significant
implications of our analysis for public officials, institutional
investors, and researchers.
Below is a more detailed summary of our analysis:
1990, Viacom Inc., a prominent media company, adopted a dual-class
capital structure, consisting of two classes of shares with differential
voting rights. This structure enabled Viacom’s controlling shareholder,
Sumner Redstone, to maintain full control over the company while
holding only a small fraction of its equity capital. At the time,
Redstone was already one of the most powerful and successful figures in
Hollywood. Indeed, three years earlier, he had bought Viacom in a
hostile takeover, exhibiting the kind of savvy and daring business
maneuvers that subsequently helped him transform Viacom into a $40
billion entertainment empire that encompasses the Paramount movie studio
and the CBS, MTV, and Showtime television networks. Investors during
the 1990s could have reasonably been expected to be content with having
Redstone safely at the helm.
Fast-forward twenty-six years to 2016: Ninety-three-year-old Redstone faced a lawsuit,
brought by Viacom’s former CEO and a long-time company director,
alleging that Redstone suffered from “profound physical and mental
illness”; “has not been seen publicly for nearly a year[;] can no longer
stand, walk, read, write or speak coherently; … cannot swallow[;] and
requires a feeding tube to eat and drink.” Indeed, in a deposition, Redstone did not respond when asked his original family birth name. Some observers expressed
concerns that “the company has been operating in limbo since the
controversy erupted.” However, public investors, who own approximately
ninety percent of Viacom’s equity capital, remained powerless and
without influence over the company or the battle for its control.
Eventually, in August 2016, the parties reached a settlement
agreement that ended their messy legal battles, providing Viacom’s
former CEO with significant private benefits and leaving control in the
hands of Redstone. Notably, despite the allegation and the evidence that
surfaced, the settlement prevented a court ruling on whether Redstone
was legally competent. Note that even a finding of legal competency
would have hardly reassured public investors: Legal competence does not
by itself qualify a person to make key decisions for a major company.
Moreover, once Redstone passes away or is declared to be legally
incompetent, legal arrangements in place would require the control stake
to remain for decades in an irrevocable trust that would be managed by a
group of trustees, most of whom have no proven business experience in
leading large public companies. Thus, even assuming that Viacom’s
governance structure was fully acceptable to public investors two
decades ago, this structure has clearly become highly problematic for
them.
Let us now turn from Viacom to Snap Inc. The company responsible for
the popular disappearing-message application Snapchat has recently gone
public with a multiple-class structure that would enable the company’s
co-founders, Evan Spiegel and Robert Murphy, to have lifetime control
over Snap. Given that they are now only twenty-six and twenty-eight
years old, respectively, the co-founders can be expected to remain in
control for a period that may last fifty or more years.
Public investors may be content with having Spiegel and Murphy securely
at the helm in the years following Snap’s initial public offering. After
all, Spiegel and Murphy might be viewed by investors as responsible for
the creation and success of a company that went public at a valuation
of nearly $24 billion. However, even if the Snap co-founders have unique
talents and vision that make them by far the best individuals to lead
the company in 2017 and the subsequent several years, it is hardly
certain that they would continue to be fitting leaders down the road.
The tech environment is highly dynamic, with disruptive innovations and a
quick pace of change, and once-successful founders could well lose
their golden touch after many years of leading their companies. Thus, an
individual who is an excellent leader in 2017 might become an
ill-fitting or even disastrous choice for making key decisions in 2037,
2047, or 2057. Accordingly, as the time since Snap’s IPO grows, so does
the risk that Snap’s capital structure, and the co-founders’ resulting
lock on control, will generate costly governance problems....MUCH MORE
