Peter Clapman (former chief investment counsel of TIAA) and Robert Koppes (former chief investment counsel of TIAA) have an interesting op-ed in today's WSJ. It starts as a victory lap for shareholder activism's victories over director primacy, but then acknowledges--contra to the claims of activists and their academic allies on the Acela corridor--that this has resulted in a deleterious short-term focus by corporate managers:
Now we see aggressive pushes for stock buybacks and calls to spin off or break up businesses and cut costs, including spending on research and development. Activists increasingly demand board representation to implement their agenda, often meaning that short-term investors take and quickly relinquish boards’ seats. Boards frequently settle with activists out of fear of losing a proxy battle—or worse, winning a Pyrrhic victory.
Surveying this new landscape, we have to ask: Have these efforts yielded a structure that protects the long-term economic interests of shareholders? If the answer is no, then it’s time to revisit earlier assumptions and return to the basic purpose of corporate governance reforms: furthering investors’ long-term interests.
Their solution? Changing the one-share/one-vote paradigm:
Long-term investors should consider pursuing enhanced voting rights that better allow them to drive a long-term agenda.
Making such a right possible in the U.S. will require work. This country’s arcane proxy-voting infrastructure makes it difficult for investors to use such mechanisms in the few cases where they currently exist. In other countries with developed markets, such as France, it is common for shareholders with long holding periods to have greater rights, albeit still with varying degrees of practical issues.
I wrote about dual class voting structures back in the 1990s:
The Short Life and Resurrection of SEC Rule 19c-4 69 Washington University Law Quarterly 565 (1991), available at SSRN: http://ssrn.com/abstract=315375
Revisiting the One-Share/One-Vote Controversy: The Exchanges’ Uniform Voting Rights Policy, 22 Sec. Reg. L.J. 175 (1994)
In that work, I posited that the strongest argument against dual class stock rests on conflict of interest grounds. There is good reason to be suspicious of management's motives and conduct in certain dual class recapitalizations. Dual class transactions motivated by their anti-takeover effects, like all takeover defenses, pose an obvious potential for conflicts of interest. If a hostile bidder succeeds, it is almost certain to remove many of the target's incumbent directors and officers. On the other hand, if the bidder is defeated by incumbent management, target shareholders are deprived of a substantial premium for their shares. A dual class capital structure, of course, effectively assures the latter outcome.
In addition to this general concern, a distinct source of potential conflict between managers' self-interest and the best interests of the shareholders arises in dual class recapitalizations. An analogy to management-led leveraged buyouts ("MBOs") may be useful. In these transactions, management has a clear-cut conflict of interest. On the one hand, they are fiduciaries of the shareholders charged with getting the best price for the shareholders. On the other, as buyers, they have a strong self-interest in paying the lowest possible price.
In some dual class recapitalizations, management has essentially the same conflict of interest. Although they are fiduciaries charged with protecting the shareholders' interests, the disparate voting rights plan typically will give them voting control. The managers' temptation to act in their own self-interest is obvious. Yet, unlike MBOs, in a dual class recapitalization, management neither pays for voting control nor is its conduct subject to meaningful judicial review. As such, the conflict of interest posed by dual class recapitalizations is even more pronounced than that found in MBOs.
While management's conflict of interest may justify some restrictions on some disparate voting rights plans, it hardly justifies a sweeping prohibition of dual class stock. First, not all such plans involve a conflict of interest. Dual class IPOs are the clearest case. Public investors who don't want lesser voting rights stock simply won't buy it. Those who are willing to purchase it presumably will be compensated by a lower per share price than full voting rights stock would command and/or by a higher dividend rate. In any event, assuming full disclosure, they become shareholders knowing that they will have lower voting rights than the insiders and having accepted as adequate whatever trade-off is offered by the firm in recompense. In effect, management's conflict of interest is thus constrained by a form of market review.
I therefore proposed an exchange listing standard that was carefully tailored to remedy the conflict of interest problems posed by dual class recapitalizations, without being overbroad. That proposal was based on state corporate law rules governing transactions posing conflict of interest concerns similar to dual class recapitalizations: two-tier tender offers, freeze-out mergers, and interested director transactions. As it turned out, my proposal basically tracked the proposal put forth by AMEX and thereafter ignored by the Commission. Because I believe that my proposal or one similar to it, such as the AMEX proposal, is a better solution to the dual class stock problem than the pending proposal, a brief review and update of the proposal's main points follows.
The proposal looked first to the type of transaction in question. Any rule should be limited to true dual class stock transactions, thereby eliminating one class of overbreadth concerns by precluding application to other corporate actions. Second, for the reasons discussed above, no safeguards over and above those already provided by state law are necessary with respect to dual class stock issued in an IPO, a subsequent offering or dividend of lesser-voting stock, or dual class stock issued in a bona fide acquisition. Nor are any additional safeguards necessary with respect to super-voting rights shares issued without transfer restrictions or in a lock-up. An exchange listing standard should therefore permit issuers to freely adopt those plans.
Transactions involving more subtle conflicts require some additional safeguards. Among these are exchange offers and recapitalizations creating super-voting rights stock bearing transfer restrictions. In order to dissipate the conflicts of interest they raise, they should be permitted only if they are approved by the corporation's independent directors and disinterested shareholders.
Requiring approval by a committee of independent board members created to negotiate with management and/or the controlling shareholder is common in conflict of interest transactions. In the freeze-out merger context, the Delaware Supreme Court has made clear that this procedure is "strong evidence that the transaction meets the test of fairness." Statutes governing interested director transactions and two-tier tender offers effectively presume that the transaction is fair if approved by the independent directors. There is always, of course, some risk that purportedly independent directors will be biased in favor of their compatriots, but courts give greatest deference to independent directors in contexts like this one in which a market test of the transaction is impractical. This is so in large part, of course, because the absence of a market test gives courts little option but to rely upon independent directors as the chief accountability mechanism. Yet it is also so because courts know that independent directors are capable of serving as an effective accountability mechanism. Despite the potential for structural or actual bias, independent directors have affirmative incentives to actively monitor management and to discipline managers who prefer their own interests to those of shareholders. If the company suffers or even fails on their watch, for example, the independent directors' reputation and thus their future employability is likely to suffer. Guided by outside counsel and financial advisers and facing the risk of person liability for uninformed or biased decisions, disinterested directors therefore should be an effective check on unfairness in a dual class recapitalization.
As for the possible use of dual class stock to encourage long-term investment, there are many historical precedents. One share-one vote is not the historical norm. To the contrary, limitations on shareholder voting rights in fact are as old as the corporate form itself.
Prior to the adoption of general incorporation statutes in the mid-1800s, the best evidence as to corporate voting rights is found in individual corporate charters granted by legislatures. Three distinct systems were used. A few charters adopted a one share-one vote rule. Many charters went to the opposite extreme, providing for one vote per shareholder without regard to the number of shares owned. Most followed a middle path, limiting the voting rights of large shareholders. Some charters in the latter category simply imposed a maximum number of votes to which any individual shareholder was entitled. Others specified a complicated formula decreasing per share voting rights as the size of the investor's holdings increased. These charters also often imposed a cap on the number of votes any one shareholder could cast. Another approach used time-phased voting, in which investors got more votes as the period in which they had held their shares increased.
U San Diego Law professors Lynne Dallas and Jordan Barry did a study of time-phased voting and found that:
We explore Time-Phased Voting (“TPV”), an arrangement in which long-term shareholders receive more votes per share than short-term shareholders. TPV has gained prominence in recent years as a proposed remedy for perceived corporate myopia.
We begin with theory, situating TPV relative to other corporate voting structures such as one-share-one-vote and dual-class stock. By decreasing the influence of short-term shareholders, TPV may encourage managers to act in the long-term interests of their firms. It may also facilitate controlling shareholder diversification and firm equity issuances by enabling controlling shareholders, who are generally long-term shareholders, to maintain their control with lower levels of ownership. In this respect, it resembles a milder form of dual-class stock, but is more targeted toward myopic behavior.
We then investigate U.S. companies’ experiences with TPV in practice. Due to limited U.S. experience with TPV, our sample size is small from a statistical standpoint. Nevertheless, our findings are consistent with our theoretical analysis. Our ownership and voting data suggest that TPV empowers long-term shareholders, but that it does little to encourage long-term shareholding; this may be due to a lack of investor awareness regarding the few companies that have TPV. In the short term, TPV empowers insiders, increasing their control and creating a wedge between their ownership and control of the firm (though a smaller wedge than is typical of dual-class firms). However, in the long term we find that TPV is associated with reduced insider ownership and control. We see a transition in TPV companies, which are mainly mature, family-owned companies, from a concentrated to a more dispersed ownership structure. Relatedly, we find that TPV is associated with significant insider diversification and the issuance of additional equity.
Overall, TPV firms significantly outperformed the market as a whole; an investor who invested in our TPV firm index in 1980 would have more than six times as much money at the end of 2013 as an investor who invested in the S&P 500. While it is not clear that TPV contributed to this strong performance, we believe that shareholders and corporations should be free to experiment with reasonable TPV plans if they so choose.
Long-Term Shareholders and Time-Phased Voting (July 2, 2015). 40 Delaware Journal of Corporate Law 541 (2015); San Diego Legal Studies Paper No. 15-194. Available at SSRN: http://ssrn.com/abstract=2625926
Those interested in this topic should also take a look at Tenure Voting and the U.S. Public Company.
I see no reason why my proposal should not be adopted to allow time-phased voting plans, so maybe this is time to get that ball rolling.