Editor’s Note: This article originally appeared in the April 2017 issue of Asia Asset Management.
With Less Accountability to Shareholders Comes Greater Risk
Investors bought shares in Snap Inc. (Snap), the parent company of Snapchat, despite a high valuation, slowing user growth, and governance criticism from fund managers — red flags that could embolden other unprofitable start-ups to do the same. Snap is setting a dangerous precedent and it represents a setback for investor protection and corporate governance.
In an era when investors are demanding the highest standards of governance at public companies, Snap’s recent listing poses an interesting question: how far are shareholders willing to chase gains in exchange for their votes?
Not very far, it seems, if the company’s share price is any indication. Snap opened at US$24 a share on 2 March, but despite a pop of 44% on the first day of trading, the shares dropped 17% to below $20 a week after its $3.4 billion public listing. Media reports have also disclosed a number of sell ratings on the stock, highlighting analysts’ views that the company’s valuation may be too high for an operation waiting to turn a profit.
Snap made history by being the first company that issued non-voting shares in its initial public offering (IPO). While other tech companies listed and traded in the US have shares with no voting rights (e.g., Google), Snap was the first and only one to have offered only non-voting shares at the time of its IPO. By doing so, Snap implemented a dual-class share structure where founders retain super-voting shares, while denying IPO shareholders voting rights.
According to regulatory filings, the founders of the camera company with the vanishing message app Snapchat are keeping a 22.4% stake each in Class C shares, shares that have 10 votes each and give the founders 88.5% of voting power in the company. “Mr. [Evan] Spiegel and Mr. [Robert] Murphy, and potentially either one of them alone, have the ability to control the outcome of all matters submitted to our stockholders for approval, including the election, removal, and replacement of directors and any merger, consolidation, or sale of all or substantially all of our assets. If Mr. Spiegel’s or Mr. Murphy’s employment with us is terminated, they will continue to have the ability to exercise the same,” Snap says in the filings.
With less accountability to shareholders comes greater risk: Can this be the standard for other large IPOs?
At CFA Institute, we believe shareholders should have the right to vote. A one-share, one-vote standard offers better investor protection than uneven or non-existent voting rights; in particular, the potential to hold directors accountable is a right of critical importance.
The current Snap share structure gives its founders control and voting power that are disproportionate to their shareholding and disenfranchises other shareholders. Without the power to vote, holders of Snap shares have limited ways of influencing management and the direction of the company.
This is an issue that some investors are willing to overlook in an environment of rising share prices. But when sentiment turns, shareholders are left with an instrument that has neither voting rights nor coupon in a company that, in this instance, has yet to demonstrate a track record in making profits or paying a dividend.
Large pension funds and asset managers in the US, including the California Public Employees’ Retirement System (CalPERS), have reacted strongly against Snap’s decision to issue only non-voting shares. They denounced the move as damaging from the perspectives of corporate governance and investor protection.
Yet, Snap can’t be completely ignored by the market. Given its size, Snap could be included in a number of stock indices, forcing index trackers and other passive funds to acquire the stock to avoid deviating from such indices and benchmarks. That said, S&P Dow Jones Indices require a track record of profitability, one of several criteria factored for before inclusion. FTSE and Russell indices weigh investor feedback when considering inclusion. And according to a recent article from Reuters, MSCI USA index is facing pressure from institutional investors to exclude new no-vote companies. CFA Institute would welcome this development.
Going public as a controlled company with a dual-class unequal-voting-rights structure is not new nor an assurance for long-term success. Some companies that lack effective accountability to owners soar for a time, but others crash and burn. Others pursue misguided strategies for far too long.
E-commerce marketplace Groupon and mobile game maker Zynga are examples of technology companies that went public with a dual-class share structure, facing challenges including governance concerns. Their share prices have tumbled since their IPOs despite the so-called “long-termism” that dual-class structures are supposed to offer. On the other hand, technology behemoths, such as Apple, Microsoft, and Amazon, have thrived under a one-share one-vote structure.
Currently in Asia, discussions about dual-class share listings are high on the agenda. In Hong Kong, where the culture of retail investor participation is more pronounced than in other developed markets, investor protection is being given appropriate consideration and weight. Dual-share structures are currently banned in the city, as they are in Singapore where conversations around allowing dual-class share listings have been revived.
E-commerce giant Alibaba Group Holding’s 2014 decision to list in New York — rather than its more intuitive home of Hong Kong — sparked a debate on whether governance structures that give certain persons voting power or other rights disproportionate to their shareholding should be allowed when seeking listing in Hong Kong.
This led to a public consultation where the Stock Exchange of Hong Kong (SEHK) concluded in 2015 that a one-share, one-vote standard should prevail. However, the exchange also said that a weighted voting right structure that includes a dual-share class standard should be allowed for certain companies, in certain circumstances, and with certain safeguards. It is reported that SEHK plans to consult the market again, but this time on the launch of a third board where dual-class shareholding structure can be explored.
Singapore is confronted with similar challenges, and the Singapore Stock Exchange (SGX) is consulting the market on whether dual-class structures should be allowed and if so, what safeguards should be put in place. In a recent survey, the majority (60%) of respondents to a CFA Singapore Society member survey rejected the idea of dual-class share structures for listed companies there. Interestingly, however, an equal number of respondents said they would acquire shares in companies with dual-class share structures as those who would avoid them. They all agree, however, that safeguards should be put in place to protect investors. Stay tuned: The SGX consultation closes on 17 April.
While exchanges and regulators consider what they stand to gain by allowing the next Alibaba or Snap to list in their cities, they should also consider what they stand to lose. More specifically, there is real risk that promoters will shift assets out of already listed companies, or take them private and re-list them in newly listed vehicles with extraordinary share structures. That could materially impact the markets, as well as other metrics and rankings.
There is merit in the argument that given the culture of technology companies and the nature of private equity participation in these companies, promoters of such companies may have very low levels of equity by the time they list, and this is not desirable. Rather than allowing dual-class share structures, exchanges and regulators should explore alternative measures to make a financial centre more attractive for local technology stock listings.
Companies select listing venues based on many factors, including liquidity, valuation, investor access, peer group comparison, and regulatory requirements. From both a competitive and a corporate governance standpoint, it is important to consider the long-term reputational consequences for the market and what truly makes a market unique, rather than succumbing to the short-term seductions of attracting a larger number of new listings that may expose investors to undue corporate governance risks.
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Photo Credit: ©Getty Images/Drew Angerer