Google's dual class stock

Lynn Stout and Iman Anabtwai write in today's WSJ that

investor enthusiasm for Google's IPO suggests the SEC may be wrong about whether investors really want, or need, more shareholder democracy.

They're referring to Google's dual class capital structure that gives the founders more power than the outside shareholders, a device the SEC has long crusaded against, as it has other restrictions on shareholder power. Stout and Anabtwai speculate that shareholders may like this structure, among other reasons, because they think

strong boards can mediate not only conflicts among shareholders, but also conflicts between shareholders and other important corporate constituencies. The "team production" theory of corporate governance teaches that a principal function of board governance is to encourage executives, customers, rank-and-file employees, and others to make long-term commitments to a company by assuring these groups corporate policy will not be set by an anonymous, myopic, return-hungry pack of shareholders. Shareholders go along because, by ceding control to boards, they get greater loyalty and commitment from others. Google's investors may well believe the firm's founders and employees will work harder and better with a dual-class structure that protects them against hostile takeovers or shareholder pressures to raise profits by outsourcing jobs and cutting employee benefits.

Thus, the authors conclude:

The SEC should take a lesson from Google. The IPO market already allows entrepreneurs and investors to arrange their business affairs in a fashion that benefits all. The SEC should respect that ability rather than imposing its own bureaucratic view of what is "good corporate governance."

Professor Bainbridge analyzes Stout and Anabtwai's arguments for the benefits of dual class stock. His work, to which he links in the post, effectively rebuts the "team production" argument.

Despite my reservations about the team production model, I have to say that I like where Stout and Anabtwai end up: Regulators should lay off corporate governance. S & A and I may have different predictions about where the market will and should end up, but that disagreement is a reason we should let the market decide.

One problem with their analysis, though: Investors' "enthusiasm" for Google doesn't tell me that much (assuming they are enthusiastic, about which we've been hearing some doubts lately). If we want to use this transaction to measure what investors think, we'd need to determine how much they're discounting the stock for the lack of control. That would require a regression.

If investors are discounting the stock, then S & A's arguments about what shareholders want based on this transaction would unravel. What we would learn is that the founders believe it's worth it to them to hang onto control and whatever perks it brings them. But in the absence of lies or some other market problem, we could still conclude that this is the way the parties to the firm's nexus of contracts want it. In other words, there's still no reason for the SEC to intervene.

PS: The SEC is apparently recrafting its shareholder ballot access rule to make it more palatable to its objectors. Donaldson is thinking about having managers and shareholders negotiate over nominees. Hey, great idea -- let's not only mess with corporate governance, but also slow it down and introduce more strategic maneuvering. Now if we could only get the SEC to manage Iraq we'd really be in good shape.

PPS: Steve Bainbridge has a good critique of this misguided attempt to revise this misguided proposal.

Comments

[Tom Grey]

You're correct that, if the shareholders are discounting the stock (lower price; lower amount of capital raised for the company) due to the structure, it STILL might be more what the current owners want.

Much like when an owner of a large estate sells it -- with the proviso that only 10% of it can be developed. Lower price/ market value.

However, there's also an management honesty issue -- here the (former owner) management has transparent control, and new owners know it. In so many other corps mgrs have effective but nearly invisible control, and fund manager owners act like they don't know it. I'm not sure what this means though. I guess the increase in transparency should tend to put a counter-premium on the value of subordinate shares.