Lucian Bebchuk and Kobi Kastiel's have an interesting new article The Untenable Case for Perpetual Dual-Class Stock (April 18, 2017). Harvard Law School John M. Olin Center Discussion Paper No. 905; Harvard Law School Program on Corporate Governance Discussion Paper 2017-6 . Available at SSRN: https://ssrn.com/abstract=2954630 or http://dx.doi.org/10.2139/ssrn.2954630. They claim that:
The desirability of a dual-class structure, which enables founders of public companies to retain a lock on control while holding a minority of the company’s equity capital, has long been the subject of a heated debate. This debate has focused on whether dual-class stock is an efficient capital structure that should be permitted at the time of initial public offering (“IPO”). By contrast, we focus on how the passage of time since the IPO can be expected to affect the efficiency of such a structure.
Our analysis demonstrates that the potential advantages of dual-class structures (such as those resulting from founders’ superior leadership skills) tend to recede, and the potential costs tend to rise, as time passes from the IPO. Furthermore, we show that controllers have perverse incen- tives to retain dual-class structures even when those structures become in- efficient over time. Accordingly, even those who believe that dual-class structures are in many cases efficient at the time of the IPO should recog- nize the substantial risk that their efficiency may decline and disappear over time. Going forward, the debate should focus on the permissibility of finite-term dual-class structures that is, structures that sunset after a fixed period of time (such as ten or fifteen years) unless their extension is approved by shareholders unaffiliated with the controller.
I want to take issue with their pro-regulation conclusion that sunset provisions should be imposed. They argue that capital markets cannot adequately price dual class structures.
Whereas IPO buyers might pay attention to and price a sali- ent feature like a dual-class structure, they might not similarly price more subtle features, such as the presence and specifics of a sunset provision.107
107 Bebchuk, supra note 15, at 740–42 (discussing the pricing of governance terms). [Lucian Arye Bebchuk, Why Firms Adopt Antitakeover Arrangements, 152 U. Pa. L. Rev. 713 (2003).]
This is a highly contested claim, which goes to the heart of their argument, but the only support they offer for their position is a citation to a 14 year old article by one of the authors.
But let's assume they're right. Their argument is still highly paternalistic. They basically are saying that investors can't be trusted to decide for themselves whether to buy perpetual dual class stock. For useful (albeit dated) analyses of why paternalistic policies (as embodied in mandatory rules) toward shareholders are inappropriate, see Jeffrey N. Gordon, The Mandatory Structure of Corporate Law, 89 COLUM. L. REV. 1549, 1556-66 (1989); Roberta Romano, Answering the Wrong Question: The Tenuous Case for Mandatory Corporate Laws, 89 COLUM. L. REV. 1599 (1989). Personally, I side with the late Larry Ribstein:
... any rationality and cognition problems that may exist do not justify refusing to enforce an entire class of long-term contracts. If a contract is invalid merely because one of the parties could not clearly and objectively foresee the future or did not accurately anticipate the particular result that occurred, then any executory contract is in jeopardy, including rules on voting, exit, or compensation in business associations. Yet courts commonly enforce these rules, and no anticontractarian has asserted that such rules generally should not be enforced.Larry E. Ribstein, Fiduciary Duty Contracts in Unincorporated Firms, 54 Wash. & Lee L. Rev. 537, 555 (1997).
The case against paternalism seems even stronger these days, when institutional investors increasingly dominate the capital markets. After all, as Jeffrey Gordon pointed out almost two decades ago:
.., the IPO market has a heavy institutional component. The SEC's 1971 Institutional Investor Study indicated that institutional investors purchased nearly one third of the shares of a large group of randomly selected IPOs during the 1968-69 period. In light of the increasing institutionalization of markets over the two subsequent decades, it seems highly probable that current institutional participation would be even greater. Since issuers must offer securities on the same terms to all investors, unsophisticated investors can free ride on the efforts of sophisticated investors even in the IPO market.
Jeffrey N. Gordon, The Mandatory Structure of Corporate Law, 89 Colum. L. Rev. 1549, 1557–58 (1989). Gordon concluded: "mandatory law cannot be justified on the basis of an information asymmetry between investors and promoters." Id. at 1564. Surely that is even more true today than it was back in 1989.
In sum, I'm in favor of letting people choose for themselves, even when corporate law academics think they will choose unwisely.
