An editorial by Bloomberg whines that Silicon Valley is "retreating" on shareholder rights. In the course of which, they reveal a fundamental misunderstanding of the shareholder contract and the IPO process:
LinkedIn Corp., Zynga Inc. and Groupon went public late last year with dual-class shares, which grant their founders and directors super-voting rights to trump ordinary shareholders’ one vote per share. If a corporate raider tries to oust the management, the dual-class shares will protect them -- even if they are performing badly.
And then there’s Google Inc., which already has two share classes. It announced last month that it would issue a third class with no voting rights whatsoever. ...
Harvard law professor Lucian Bebchuk and two co- authors have created an entrenchment index, or e-index, to evaluate a company’s governance. It includes staggered boards, in which only a certain number of a company’s directors face election each year, an arrangement that acts as a powerful defense against removal of an ineffective board through a proxy fight. The index also includes poison pills, which ward off hostile takeovers, and golden parachutes, which richly reward top executives if there is a change of control at the company. ...
Numerous companies have recently agreed to consider ending staggered boards, also known as classified boards. Studies by Bebchuk, a leader in efforts to end the practice, show that such boards depress a company’s value. But Silicon Valley’s dual-class model probably has more entrenchment power than staggered boards ever did.
When a company goes public, it enters into a compact with shareholders. If it has no intention of keeping its part of the bargain, it should stay private.
In the bolded phrase, Bloomberg gets it exactly backwards. What happens in an IPO is kind of like what happens when you buy a car. A car buyer goes to the dealer and exchange money for a car in a transaction governed by a standard form contract drafted by the dealer. If the buyer doesn't like the terms of the contract, he typically is faced with two choices: Discount the price he's willing to pay for the car or simply refuse to invest. If the car buyer goes forward with the purchase, we thus can assume that the investor has priced the terms of the contract and is willing to pay the specified price to get the car subject to the contract terms on offer.
When a shareholder buys stock in an IPO, the shareholder exchanges money for shares in a transaction governed by, inter alia, the organic documents drafted by the issuer (in consultation with the underwriters and other advisers). If those organic documents contain provisions like dual class stock or classified boards, to which a particular shareholder objects, that shareholder has the same choice our hypothetical car buyer faces: Walk away or discount the price you're willing to pay.
If the shareholder goes forward with an investment in the IPO, we can infer that the shareholder has priced the terms of the corporate compact as set forth in the firm's organic documents. As such, we also can infer that the shareholder has accepted the trade-off inherent in buying stock whose terms depart from the statutory norms.
A company that enforces the terms of the corporate governance arrangements as they existed at the time of the IPO thus is keeping its part of the bargain.
The folks who aren't keeping their side of the bargain are activist investors, egged on by folks like Bloomberg and Bebchuk, to unwind classified boards and the like. Those investors made their bed when they bought stock subject to such provisions, but now they're refusing to lie in those beds.
If there is room for moral condemnation in this context, a point on which I shall not take a position here, it strikes me that it's the activists and their cheerleaders who are to be held up to disapprobation.