Turkish Law Blog
Control Enhancing Mechanisms: Prioritizing Long-Term Company Success over Short-Term Shareholder Interests
The conventional shareholder value maximization-oriented corporate governance discussions are very likely to undermine long-term success of companies at their post-IPO stages. It is a matter of fact that, investors are likely to prioritize protecting their investments instead of contributing to the long-term development of the companies they have invested in. In this regard, for instance, investors mostly demand protection rights such as liquidating rights, control, and voting rights. At a post-IPO stage, this short-term approach of investors’ usually leads start-up companies to fail to preserve their innovative spirits, dynamism and entrepreneurial approaches, thus their ability to remain competitive in today’s extremely competitive market. Effective corporate governance structures in this regard, would enable companies to develop at a face pace and remain dynamic by preserving their ability to make the decisions, changes and responses as fast and efficient as it is possible.
Apart from companies that choose to remain private, innovative and successful public companies typically implement control-enhancing mechanisms that give the founders a tight grip on the control over the newly-listed companies’ destiny over long time horizons. Mostly, companies implement diversified techniques to retain majority voting power, such as pyramid structure or dual-class share structures. The reason is same here: To avoid the involvement of short-term expectations of disinterested shareholders, thereby retaining the ability to focus on innovation and growth.
As dual class share structure is very common in successful public companies, this article will present the possible benefits of this mechanism, with a view to provide a guideline for start-up companies to remain innovative and successful even after their IPOs. With this respect, by adopting dual class share structures, start-up companies may implement different class of stocks, so that these different classes provide diversified rights to the stockholders, such as appointing certain number of board members, or having more voting power per share. Usually, these stocks are held by founders or insiders who aim to retain control of the company. Many conventional arguments state that owners implement control enhancing mechanism to maintain control and aim to receive private interest from the company.
Ignoring the crucial benefits of control enhancing mechanisms, and in particular dual class share structures, the conventional corporate governance experts argue that such mechanisms threaten the interests of shareholders. According to conventional arguments, issuing multiple series of stocks would cause a defect on the governance structures, since according to this view, the main goal of governance principles is the monitoring of the managers in order to prevent their detrimental misbehaviors against shareholders’ interests.
However, implementation of dual class share structure enables companies to differentiate voting rights and capital rights, which then enables the founders of these companies to play a more active role in the decision-making processes. In turn, product-oriented founders’ increased power in the decision-making processes allows them to focus on developing their businesses, by standing apart from the shareholders’ incentive to maximize their returns in a short period of time. Enabling the product and long-term growth-oriented companies to play a more active role in the decision-making processes will eventually increase companies’ ability to serve innovative and disruptive products and/or services to the market, which will in turn ensure the long-term success of these companies. At the end, of course, the shareholder value will be maximized too.
Consider, for instance, Google. The company has a multi-class structure and is essentially managed by three executives. … Eric Schmidt (Executive Chairman of the Board of Directors), Larry Page (co-founder and Chief Executive Officer (CEO)) and Sergey Brin (co-founder and member of the board of directors). The executives owned approximately 92 percent of the outstanding class B shares, giving them about 65 percent of the firm’s total voting power while their economic interest (cash-flow rights) was only approximately 20 percent.
In 2004 Google made its Initial Public Offering and released an IPO Letter that was written by its founders. With this letter, as provided below, founders explained why they choose to implement dual class of shares:
“Standard structure of public ownership may jeopardize the independence and focused objectivity that have been most important in Google's past success and that consider most fundamental for its future. Therefore, we have implemented a corporate structure that is designed to protect Google's ability to innovate and retain its most distinctive characteristics.”
It’s been 15 years after that statement was released. Google investors received %900 returns. In other words, founders of the Google were right at that time by prioritizing the focus on Google’s best interests rather than the shareholders’ short-term interests.
Together with the Google example, Facebook’s structure may illustrate the meaning of the statements of the founders of Google. According to the statement of beneficial ownership of Facebook, Mark Zuckerberg holds approximately 19.6% of the equity of the company while holding 57% of the voting powers. This voting power provided Mark Zuckerberg with an important autonomy on the company decisions. Regardless of what conventional approach suggests, the investors of the Facebook gained almost 301.33% from 2012 to 2015. In other words, investors who trust in owners received high amount of economic interests no matter what corporate experts say.
Again, consider Tesla. The company is valued more than $40 billion without having considerable profits. The reason for this is the investors’ trust in Elon Musk as the Chairman and the CEO of Tesla, and in the governance structure of the company that allows product-oriented founder to involve in decision making process and focusing on the long term strategies. Elon Musk states that; their main objective is creating an electric-based getable car which is affordable for majority of the society . However, to achieve this dream, Elon Musk and his team introduced luxury cars which allow them to receive adequate capital to fund diversified models. The value creation and growth-oriented vision of Elon Musk, as presented with this example, shows the reason why investors have trust in the company and Elon Musk.
In line with the above, Surowiecki states that “when the right person is in charge the dual-class structure can help companies avoid one of the problems besetting modern business, the short-termism…”
As said, in today’s extremely competitive and fast-changing world, companies have to be agile and adaptive to the fast-changing market conditions. Thus, it is even the case that public companies considering going private again. For instance, Mark McSherry provides the example of Blackberry in his article titled, “70 Billion Reasons for a Public Company to Go Private” and he explains that Blackberry’s stock price experienced a fall from $80 billion to $6 billion in the last five years, which caused the company to consider going private again. The author continues to explain that, Blackberry is only one of the many companies that consider going private, because being a public company imposes a considerable amount of workload, especially in terms of ensuring transparency, due to a great deal of responsibility of these companies towards the regulators and shareholders. The same article presents Dell as the second example of the companies that are planning to go private. With this respect, after losing almost half of its value in recent years, the founder of the company, Micheal Dell, plans to buy the company back with private equity help.
The underlying reason why these companies plan to go private again is the same with the reason why many companies prefer to stay private in the first place: to remain in a safe harbor so as to have more room to create and to focus on their long-term strategic plans, without being concerned with the short-term expectations of the public.
All in all, despite conventional corporate governance understanding heavily, criticizes control-enhancing mechanisms, dual-class or multi-class share structures may, in fact, make valuable contributions to the long-term success of start-up companies at the post-IPO stage and would even be considered as a very crucial step towards to preservation of their dynamism, innovative processes and therefore their competitiveness.
- Fenwick Mark, Vermeulen Erik (2015). The New Firm Staying Relevant, Unique & Competitive. Lex Research Topics in Corporate Law & Economics Working Paper No. 2015-5 , Retrieved from http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2659763
- McSherry Mark (2013). Forbes.com. 70 Billion Reasons for a Public Company to Go Pri-vate Retrieved from http://www.forbes.com/sites/markmcsherry/2013/08/16/70billion-reasons-fora- public-company-to-go-private/#155eb0302ed0
- Vermeulen Erik (2015). Corporate Governance in a Networked Age., Retrieved from http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2641441
- Aksinaviciute Gerda (2014). More Equal than Others: Dual-Class Shares and Their Future. Tilburg University Master Thesis, Retrieved from http://arno.uvt.nl/show.cgi?fid=135817
- McCahery Joseph, Vermeulen Erik (2014). Six Components of Corporate Governance That Cannot be Ignored. Lex Research Topics in Corporate Law & Economics Working Paper No. 2014-2. Retrieved from http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2406565
- Edelstein Stephen (2013). Motor Authority. Tesla Model E To Debut At 2015 Detroit Auto Show? Retrieved from: http://www.motorauthority.com/news/1089176_tesla-model-e-to-debut-at-2015-detroit-auto-show
(McCahery, Vermeulen 2014)
(Aksinaviciute, 2014); Google, 2004 Founders’ IPO Letter from the S-1 Registration Statement, see: (Google, 2004 Founders' IPO Letter)
(Aksinaviciute, 2014); Form SC 13G Statement of Beneficial Ownership