How the mobile-messagign app company's new stock structure will undermine investors, corporate governance and the courts
By Charles M. Elson and Craig K. Ferrere
This week, index provider MSCI announced it is temporarily leaving Snap Inc. out of its indexes because of what it deems an unfair shareholder voting structure, joining a growing chorus of skeptics who see such models as an insider boon.
“MSCI will temporarily treat any securities of companies exhibiting unequal voting structures as ineligible for addition to the MSCI ACWI Investable Market Index (IMI) and MSCI US Investable Market 2500 Index,” the company said in a statement.
Increasingly, company founders have been opting to shore up control by creating stock ownership structures that undercut shareholder voting power, where only a decade ago almost all chose the standard and accepted one-share, one-vote model.
Now the Snap initial public offering (IPO) takes it even further with the first-ever solely non-voting stock model. It’s a stock ownership structure that further undercuts shareholder influence, undermines corporate governance and will likely shift the burden of investment grievances to the courts.
By offering stock in the company with no shareholder vote at all, Snap – the company behind the popular mobile-messaging app Snapchat that’s all about giving a voice to the many – has acknowledged that public voting power at companies with a hierarchy of stock ownership classes is only a fiction. And it begs the question: Why does Snap even need a board?
Without the ability for shareholders to vote for directors and maintain accountability, directors are in the end just products of the company managers.
Snap’s multi-class, non-voting capitalization gives Evan Spiegel and Robert Murphy, the company’s founders, and holders of 10-vote shares, a perpetual lock on control, without the need to hold an expensive ownership position. They exercise a decisive 89% of the voting power, despite holding only about 44% of the company’s total equity.
Dual- and multi-class capitalizations – in which founders and other insiders retain a class of high-vote shares while selling low-vote shares to the public – are nothing new for controlled companies. This mechanism has long allowed founding individuals and families to leverage minority economic ownership positions – say 10 or 20% – into total voting control of large companies such as Snap, Facebook and Google.
The no-vote structure will allow its co-founders Spiegel and Murphy, 26 and 28 years old respectively, to control the company until the day both are dead.
Its board, totally controlled by them, instills little confidence amongst the non-voting shareholders.
But the Snap plan stretches this logic to its limit – with no-vote shares, founders can sell off all but one voting share and nonetheless control every aspect of company policy.
With zero-vote IPO stock, the logic of leveraging control from a minority interest through the dual-class structure has now reached its illogical conclusion. With non-voting shares, a founder can now advise investors plainly, without any pretense or suggestion otherwise, that he or she will take their money but not their advice.
The zenith has been reached, and in its wake is the normalization of the disenfranchisement of public shareholders through dual- and multi-class structures.
Today 9% of the S&P 100 – representing a staggering $2.26 trillion in market capitalization – is dual-class. In the Russell 3000, such companies represent 8.2% of the index. Now, the phenomenon extends well beyond the technology and media industries. Significant dual-class companies include AMC, Box, Nike, Ralph Lauren, Tyson Foods and Under Armor. Dual-class controlled companies are steadily increasing in prominence, so hard thinking about the importance of the shareholder vote is due.
While the structure is recognized as problematic for ordinary investors, its effect on how the courts should treat director decision-making in these companies has not been explored. Ultimately, no-vote stock requires courts to abandon the director-protective business judgment rule barring courts from second-guessing the business judgment of an effective board of directors for these entities, because without the voice of shareholders there is no real board oversight. That would lead to the demise of the multi-class, non-voting stock structure.
More than one-in-nine of the new companies being added to the Russell 300 index ranks through IPOs is dual-class. In 2015, 13.5% of the 133 IPOs listed dual-class shares, compared to just 1% in 2005.
As dual-class listings have proliferated, many companies have taken Google’s example and pushed the envelope even further. Zynga, which went public in 2011, raising over $1 billion, had a founder-only class of stock with a staggering seventy votes per share.
Snap’s issuance of shares with no vote was unprecedented: instead of having no effective voting power, its new shares have no actual voting power. The no-vote structure will allow its co-founders Spiegel and Murphy, 26 and 28 years old respectively, to control the company until the day both are dead.
Its board, totally controlled by them, instills little confidence amongst the non-voting shareholders. In this circumstance, why even have a board? Of course, the law and its desire to protect other investors, however limited its ability is, suggests otherwise. The growing number of dual-class companies in the American economy raises serious questions about how the courts will view transactions involving these companies in light of the accountability that a meaningful shareholder vote provides.
Charles M. Elson is the Edgar S. Woolard Jr. Chair in Corporate Governance and director of the John L. Weinberg Center for Corporate Governance, University of Delaware. He can be contacted at firstname.lastname@example.org.
Craig K. Ferrere served as the Edgar S. Woolard Jr. Fellow in Corporate Governance at the Weinberg Center from 2010-2014.