Aujourd’hui, je souhaite vous familiariser avec la réalité de la nouvelle loi californienne eu égard à la mise en place de quotas pour accélérer la diversité sur les conseils d’administration.
Cet article paru sur le site de Harvard Law School Forum on Corporate Governance, par David A. Katz et Laura A. McIntosh, associés à la firme Wachtell, Lipton, Rosen & Katz, explique le contexte menant à la nouvelle législation californienne.
La Californie se distingue par l’originalité et par le caractère affirmatif de sa loi sur la composition des conseils d’administration. Bien entendu, cette loi a ses détracteurs, notamment les chambres de commerce qui redoutent les impacts négatifs de la loi pour les plus petites entreprises qui ont des CA composés essentiellement d’hommes !
Mais, il faut noter que l’état de la Californie est le seul état américain à avoir légiféré sur la diversité des membres de conseils d’administration en proposant des mesures qui s’apparentent aux quotas imposés par plusieurs pays européens.
Voici un extrait de l’article qui résume assez bien le contenu de cette loi.
Bonne lecture ! Vos commentaires sont les bienvenus.
The bill that passed the California State Senate at the end of May 2018 would, if enacted, require any public company with shares listed on a major U.S. stock exchange that has its principal executive offices in California to have at least one woman on its board by December 31, 2019. By year-end 2021, such companies with five directors would be required to have two women on the board, and companies with six or more directors would be required to have three women on the board.
California has made headlines this summer with legislative action toward instituting gender quotas for boards of directors of public companies headquartered in the state. The legislation has passed the state senate; to be enacted, it must be passed by the California state assembly and signed by the governor. In 2013, California became the first state to pass a precatory resolution promoting gender diversity on public company boards, and five other states have since followed suit. The current legislative effort has come under criticism for a variety of reasons, and, while it is not certain to become law, it could be a harbinger of a broader push for public company board gender quotas in the United States. It is worth considering whether quotas in this area would be beneficial or harmful to the larger goals of gender parity and board diversity.
The California Bill
The bill that passed the California State Senate at the end of May 2018 would, if enacted, require any public company with shares listed on a major U.S. stock exchange that has its principal executive offices in California to have at least one woman on its board by December 31, 2019. By year-end 2021, such companies with five directors would be required to have two women on the board, and companies with six or more directors would be required to have three women on the board.
Section 1 of the California bill (SB 826) presents an argument in favor of establishing gender quotas: More women directors would be beneficial to California’s economy in various ways, yet progress toward gender parity is too slow. The bill cites studies indicating that companies perform better with women on their boards and observes that other countries have used quotas to achieve 30 percent to 40 percent representation. The bill notes that, of California public companies in the Russell 3000 as of June 2017, 26 percent had no women on their boards, while women composed 15.5 percent of directors on boards that have at least one woman. The bill cites further studies showing that, at current rates, it could take approximately four decades to achieve gender parity on boards. And finally, Section 1 of the bill concludes by citing studies suggesting that having at least three women directors increases board effectiveness.
The Opposing View
The California bill has been controversial. The California Chamber of Commerce filed an opposition letter on behalf of numerous organizations arguing that the bill would violate state and federal constitutions and conflict with existing California civil rights law, on the basis that it requires a person to be promoted—and another person disqualified—simply on the basis of gender. California legislators dispute that the bill requires men to be displaced by women, noting that boards can simply increase their size. This may be easier said than done, however: Because the required quota increases with board size, a company with a four-man board that did not wish to force out a current director would need to add three women to accommodate the requirements of the law by 2021. Suddenly expanding from four to seven would entail a very significant change to board dynamics. For a previously well-functioning board, the negative effects of a change that dramatic could outweigh the benefits of gender diversity.
Further, the bill’s opponents argue that prioritizing only one element of diversity would be suboptimal, especially at time when many California companies are engaged in addressing and increasing diversity by focusing on all classifications of diversity. Advocates for greater representation of ethnic minority groups on boards have expressed concerns that prioritizing gender will be detrimental to progress toward greater ethnic diversity. For purposes of increasing overall diversity, quotas are not a solution that can be applied broadly; if quotas such as those in the California bill were established not only for gender but for ethnic and other categories of diversity, the project of board composition would soon become a near-impossible logic and recruitment puzzle, as nominating committees struggled to meet mandated quotas, expertise needs, and director independence requirements, all within the board size parameters set forth in the company’s organizing documents. Board functioning and effectiveness would be severely compromised by the legislative micromanaging of board composition.
Thanks to the establishment of quotas in various European countries over the past 15 years, there is evidence as to the effect of gender quotas for boards. A 2018 Economist study found that, despite high expectations, the effects of quotas were, in some ways, disappointing. According to the Economist, greater numbers of women on boards did not necessarily produce better performance or decision-making, nor was there a trickle-down effect of boosting women’s progress to senior management jobs.
On the other hand, fears about unqualified women being put on boards, or a few qualified women being overboarded, also did not materialize. While there is a great deal of evidence showing that having women directors does produce more effective boards—and there are even indications in Europe that diverse boards are less likely to be targeted by shareholder activists—the Economist study shows that diversity achieved through government-imposed quotas may not be as beneficial as diversity achieved through private-ordering efforts.
The Big Picture
Progress toward gender diversity in the board room is accelerating. In the first fiscal quarter of 2018, nearly one-third of new directorships in the Russell 3000 went to women, and for the first time, fewer than 20 percent of companies in that index had all-male boards. Institutional investors, corporate governance activists, and many large companies have been at the forefront of this progress. State Street and BlackRock have been leaders on this issue in the United States. Similarly, in the UK—a country that has made significant efforts to improve gender diversity on boards while also resisting the imposition of quotas—the large investment funds Legal & General Investment Management and Standard Life Aberdeen Plc have said that they will vote against boards that are composed of less than 25 percent or 20 percent women, respectively. British institutional investor Hermes has said that it expects boards to include at minimum 30 percent women, and it led a failed opposition to the reelection of the chairman of mining group Rio Tinto Plc due to lack of diversity on the board. Given the effectiveness of recent efforts by the private sector, and in light of the intense resistance to quotas in the business community, government intervention to establish quotas may be unnecessary as well as undesirable.
Recent research shows that simply adding women to boards does not necessarily improve board performance. As common sense would suggest, it turns out that to be a positive factor, the gender composition of the board must be considered along with the skills and knowledge of the board as a whole in the context of the organization and its stakeholders. A 2017 academic study indicated that the “right” level of gender diversity may be proportionate to the number of female stakeholders—employees, clients, and suppliers, for example—and may vary across countries and cultures. In certain circumstances, the appropriate gender diversity ratio might well be over 50 percent women. The authors of the study caution against selecting directors based on quotas if, in so doing, gender diversity is prioritized over the expertise needs of the board.
Overall board diversity, including gender and ethnic minorities, has never been higher. According to a comprehensive 2018 study by James Drury Partners, overall board diversity is now at 34 percent for America’s 651 largest corporations, as measured by revenue and market capitalization. The level of board diversity is increasing, as 49 percent of the 449 newly elected directors at these companies represent diverse groups. Of particular note, the study revealed that the diversity distribution of the 6,225 directors currently serving on the boards of these companies corresponds very closely to the diversity of the population in the executive ranks of 222 companies studied by McKinsey & Co. and LeanIn.org. While there clearly is more room for progress toward greater diversity at both the executive and board levels, this data point shows that boardrooms are indeed mirroring the increasingly diverse leadership of U.S. business.
The benefit of mandatory quotas, as the business community has seen through European examples, is that they compel companies and shareholders to focus on board composition and to establish more formal recruitment processes in order to find the necessary directors. Such developments are certainly beneficial. That said, boards can and should focus on composition and recruitment in the absence of quotas, and indeed they are doing so to a greater extent than ever before. Proponents of gender diversity can be heartened by recent developments in the United States, as organic and market-driven efforts have produced results that increase the business community’s enthusiasm for diverse boards. A real danger of legislation like the California bill is that context-free quotas may have the effect of destabilizing boards and undermining the business case for increased gender diversity. Were that to occur, then not only boards themselves, but stakeholders, the business community, and the larger societal goals of gender parity and board diversity would suffer as well.
*David A. Katz is partner and Laura A. McIntosh is consulting attorney at Wachtell, Lipton, Rosen & Katz. This post is based on a Wachtell Lipton memorandum by Mr. Katz and Ms. McIntosh that originally appeared in the New York Law Journal.
Il y a une pléthore d’arguments qui circulent dans la littérature sur la gouvernance et qui concernent les pour et contre des fonds activistes eu égard aux avantages pour les actionnaires.Voici un article publié par Kai Haakon E. Liekefett*, président de Shareholder Activism Defense Team, paru dans récemment dans ethicalboardroom.L’auteur tente de montrer l’hypocrisie des fonds activistes de type « edge fund » eu égard aux points suivants :
In virtually every activism campaign, hedge fund activists don the mantle of the shareholders’ champion and accuse the target company’s board and management of subpar corporate governance.
This claim to having ‘best practices of corporate governance’ at heart is hollow – even hypocritical – as evidenced by at least three examples: hedge fund activists actually undermine the shareholder franchise, they weaken the independence and diversity of the board, and they waffle on their anti-takeover protection stance.
1. Undermining the shareholder franchise
Shareholders have a significant interest in maintaining their franchise: the right to elect directors, approve significant transactions such as a merger or the sale of all or a substantial part of the assets, or amend the charter of a corporation. Hedge fund activists promote themselves as ferocious proponents of this franchise and of ‘shareholder democracy’. In their campaigns, they demand shareholder votes on any matter that allegedly touches on shareholder rights, including areas where corporate law and the bylaws bestow authority on the board.
Yet, in most activism situations, activists seek to influence board decisions and obtain board seats through private settlement negotiations. The price of peace for the corporation is often accepting the addition of one or more activist representatives to the board to avoid the cost and disruption of a proxy contest. Notably, hedge fund activists will accuse directors of ‘entrenchment’ if a board does not settle and instead opts to let the shareholders decide at the ballot box. This practice of entering into private settlements to appoint directors without a shareholder vote is, of course, directly contrary to the shareholder franchise. For this reason, major institutional investors have called publicly on companies to engage with a broader base of shareholders prior to settling with an activist.
In the same vein, activists habitually accuse directors of ‘disenfranchising shareholders’ when they refresh the board in the face of an activist campaign, arguing that a board must not appoint new directors without shareholder approval. Remarkably, all these concerns for the shareholder franchise quickly disappear once a company engages in settlement discussions with an activist. In private negotiations, activists commonly insist on an immediate appointment to the board. A board’s request to delay the appointment and allow shareholders to vote on an activist’s director designees at the annual meeting is usually met with fierce resistance.
“THERE ARE NUMEROUS EXAMPLES OF CORPORATE GOVERNANCE ‘BEST PRACTICES’ THAT ACTIVISTS TEND TO IGNORE IN CONNECTION WITH THEIR CAMPAIGNS”
Note also that in these private settlement negotiations, activists almost always seek recovery of their campaign expenses and companies typically agree to some level of payment. These demands for expense reimbursement are almost never submitted to shareholders for approval. While the proxy rules expressly require dissidents to disclose ‘whether the question of such reimbursement will be submitted to a vote of security holders’, an activist hedge fund’s interest in the shareholder franchise evaporates once the fund’s own wallet is concerned. All too often, it appears that the activists’ concern for the shareholder franchise is merely for public consumption.
2. Weakening board independence and diversity
The main target of most activist campaigns is the composition of a company’s board of directors. The business model of hedge fund activism is to identify undervalued public companies whose intrinsic value is substantially higher than the share price on the stock exchange. And if the stock market undervalues a company, then it is only fair to look to those in charge of the company: the board of directors. Consequently, activists often argue that a board needs a refresh, typically calling for ‘shareholder representatives’ and ‘industry experts’ to be appointed as directors.
Of course, activists are not interested in just any type of ‘shareholder representative’ in the boardroom. The preferred director candidate is a principal or employee of the activist hedge fund itself. The reason is that activists intend to use the influence in the boardroom to push aggressively for their own agenda. And, in most cases, that agenda is to push the company to take some strategic action that will return financial value to the hedge fund in the near-term – such as a quick sale at a premium – irrespective of the company’s long-term potential.
Often, an activist will also identify the need for more ‘industry experts’ to join the board and propose experts affiliated with the activist to be added. Activists may give lip service to the need for independent director candidates but when they have to choose between placing an independent candidate or themselves on the board, their preferred candidate is an activist principal or employee. Frequently, even if they passionately argued for ‘much-needed industry expertise’ beforehand, activists are quick to drop their independent board nominee in favour of a 30-something activist employee who lacks any significant relevant experience. This is particularly true for smaller activist hedge funds but is also evident at larger companies. Last year, ISS and the Investor Responsibility Research Center Institute (IRRC) published a study of the impact of activism on board refreshment at S&P 1500 companies targeted by activists. The study found that activist nominees and directors appointed to boards by activists via settlements were nearly three times more likely to be ‘financial services professionals’ compared to directors appointed unilaterally by boards.
Moreover, while proxy advisory firms and key institutional investors increasingly demand more gender and ethnic diversity in boardrooms, most activist slates exclusively feature white, male director candidates. According to last year’s ISS/IRRC study, women comprised only 8.4 per cent of dissident nominees on proxy contest ballots and directors appointed via settlements with activists, and only 4.2 per cent of those candidates and directors were ethnically or racially diverse.
There are numerous other examples of corporate governance ‘best practices’ that activists tend to ignore in connection with their campaigns:
(a) Overboarding ISS, Glass Lewis and most institutional investors agree that a director should not sit on too many boards (in particular if the director is also an executive in his ‘daytime’ job). For activists, this seems to be a non-issue when it comes to themselves or their fund-nominated candidates. In addition, the practice of funds nominating the same people for various campaigns raises independence concerns. As noted in the aforementioned ISS/IRRC study: “Many of these ‘busy’ directors appear to be ‘go-to’ nominees for individual activists. The serial nomination of favourite candidates raises questions about the ‘independence’ of these individuals from their activist sponsors”.
(b) Director tenure Directors who sit on the same board for 10 years and more typically end up in the crosshairs of activist hedge funds, which argue that such directors are entrenched and cannot provide objective oversight. However, it is not uncommon for activist directors to remain on the board for many years if they cannot push the company into a sale.
(c) Mandatory retirement age Young activists frequently decry the high average age of boards and may target older directors as part of a campaign. By contrast, one rarely hears a call for age limits on the board from the more seasoned activists of the 1980s, who are pushing 70 years and beyond. In some campaigns, activists nominated director candidates who were 75 years old, 80 years old or even older.
3. Inconsistency on takeover defences
Activists love to attack companies for their takeover defences and perceived lack of ‘shareholder rights’. They crucify boards who dare to adopt a poison pill in response to a hostile bid or activist stake accumulation. They condemn bylaw amendments for ‘changing the rules of the game after the game has started’. And they deride classified boards as an outrageous entrenchment device whose sole purpose is to shield incumbent directors from the ballot box.
UNLOCKING VALUE Activist hedge funds want to deliver outsize returns within two years
Against this backdrop, it is fascinating and educational to observe what sometimes happens once activists join a board. Activists claim to hate poison pills unless, of course, they were able to acquire a large stake of 15 to 25 per cent before the pill was adopted. In these cases, an activist is sometimes perfectly fine with capping other shareholders at 10 per cent or less because it ensures that the activist remains the largest shareholder with the most influence.
It is also not usual for an activist-controlled board to maintain the very same bylaws the activist previously voraciously attacked in the campaign. Sometimes, activists will limit shareholder rights even further. The rights to act by written consent and call special meetings tend to be among the victims. If shareholders can act by written consent or call special meetings to remove the board, insurgents do not have to wait for an annual shareholder meeting to wage a proxy fight. However, once activists are in charge of a boardroom, these shareholder rights primarily constitute a threat to their own control.
The last example is the classified board (aka ‘staggered board’). In a company with a classified board, only a fraction (usually, one third) of the board members are up for re-election every year. Activists are fierce opponents of classified boards. Classification makes it harder for them to win a proxy fight. For example, it is more difficult to win an election contest for three board seats on a nine-member board if only three board seats are up for election and not all nine directorships. Activists also like the intimidation factor of threatening a proxy fight for control of a board. It makes it easier to settle for two or three seats if the activist starts by demanding seven or more seats. Everything changes, of course, once an activist is on the board. Then, many activists are perfectly comfortable with with it being a classified board. In settlement negotiations, activists often fight hard to be in the director classes that are not up for re-election in the near term. Occasionally, they even suggest a ‘reshuffling’ of the director classes to achieve this. Activists also often refuse to leave a classified board after a standstill expires, arguing that they need to be allowed to serve out their three-year term – even if they previously campaigned for annual director elections.
“ACTIVISTS HAVE BEEN ABLE TO CLOAK THEMSELVES IN THE MANTLE OF SHAREHOLDER CHAMPION WHILE PRIVATELY PUSHING TO INCREASE THEIR OWN INFLUENCE”
In other words, when it comes to takeover defences, activists’ perspectives depend on whether they have control of the boardroom or not. When activists are successful in ‘conquering the castle’, there is sometimes little reluctance on their part to pull up the drawbridge.
The true reason why activists love corporate governance
These examples make clear that most activists really do not care about corporate governance all that much. So why are activists so focussed on corporate governance in their campaigns? For the same reason why politicians kiss babies during political campaigns: it plays well with the voters. Most institutional investors and the proxy advisory firms ISS and Glass Lewis care deeply about governance issues. That is because they believe, with some justification, that good corporate governance will create shareholder value in the long-term. The long term, of course, is rarely the game of activist hedge funds. Most of these funds have capital with relatively short lock-ups, which means that their own investors will be breathing down their neck if they do not deliver outsize returns within a year or two.
Many activists will admit after a few drinks that their professed passion for governance is only a means to an end. Activists preach so-called ‘best practices of corporate governance’ in every proxy fight because it is an effective way to smear an incumbent board and rile up the voters who do care about governance issues.
Conclusion
Hedge fund activists have been able to cloak themselves in the mantle of a shareholder champion while privately pushing to increase their own influence. Institutional investors and proxy advisory firms should not look to activist hedge funds as promoters of good corporate practices. Activists are no Robin Hoods. They care about good corporate governance just as much as they care about taking from the rich and giving to the poor.
Kai Haakon Liekefett* is a partner of Sidley Austin LLP in New York and the chair of the firm’s Shareholder Activism Defense Team. He has over 18 years of experience in corporate law in New York, London, Germany, Hong Kong and Tokyo. He dedicates 100% of his time to defending companies against shareholder activism campaigns and proxy contests. Kai holds a Ph.D. from Freiburg University; an Executive MBA from Muenster Business School; and an LL.M., James Kent Scholar, from Columbia Law School. He is admitted to practice in New York and Germany. The opinions expressed in this article are those of the author and not necessarily those of Sidley Austin LLP or its clients.
Je vous invite à prendre connaissance du futur code de gouvernance du Royaume-Uni (R.-U.).
À cet effet, voici un billet de Martin Lipton*, paru sur le site de Harvard Law School Forum on Corporate Governance, qui présente un aperçu des points saillants.
Bonne lecture !
The Financial Reporting Council today [July 16, 2018] issued a revised corporate governance code and announced that a revised investor stewardship code will be issued before year-end. The code and related materials are available at www.frc.org.uk.
The revised code contains two provisions that will be of great interest. They will undoubtedly be relied upon in efforts to update the various U.S. corporate governance codes. They will also be used to further the efforts to expand the sustainability and stakeholder concerns of U.S. boards.
First, the introduction to the code makes note that shareholder primacy needs to be moderated and that the concept of the “purpose” of the corporation, as long put forth in the U.K. by Colin Mayer and recently popularized in the U.S. by Larry Fink in his 2018 letter to CEO’s, is the guiding principle for the revised code:
Companies do not exist in isolation. Successful and sustainable businesses underpin our economy and society by providing employment and creating prosperity. To succeed in the long-term, directors and the companies they lead need to build and maintain successful relationships with a wide range of stakeholders. These relationships will be successful and enduring if they are based on respect, trust and mutual benefit. Accordingly, a company’s culture should promote integrity and openness, value diversity and be responsive to the views of shareholders and wider stakeholders.
Second, the code provides that the board is responsible for policies and practices which reinforce a healthy culture and that the board should engage:
with the workforce through one, or a combination, of a director appointed from the workforce, a formal workforce advisory panel and a designated non-executive director, or other arrangements which meet the circumstances of the company and the workforce.
It will be interesting to see how this provision will be implemented and whether it gains any traction in the U.S.
Martin Lipton* is a founding partner of Wachtell, Lipton, Rosen & Katz, specializing in mergers and acquisitions and matters affecting corporate policy and strategy. This post is based on a Wachtell Lipton memorandum by Mr. Lipton.
Voici un article-choc publié par Chris Hughes dans la revue Bloomberg qui porte sur l’indépendance (ou le manque d’indépendance) des quatre grandes firmes d’audit dans le monde.
Il y a une sérieuse polémique eu égard à l’indépendance réelle des grandes firmes d’audit.
Cet article donne les grandes lignes de la problématique et il esquisse des avenues de solution.
Shareholders need to be the client, not company executives.
L’une des quatre grandes firmes
British lawmakers are pushing for a full-blown antitrust probe into the country’s four big accountancy firms following the demise of U.K. construction group Carillion Plc.
The current domination of KPMG, PricewaterhouseCoopers, EY and Deloitte isn’t working for shareholders. But creating more competition among the bean counters won’t be enough on its own. The fundamental problem is who the client is. The thrust of reform should be on making auditors see that their client is the investor and not the company executive. Randgold Resources is the only FTSE 100 company not to be audited by one of the Big Four !
Carillion’s accounts weren’t completely useless. Recent annual reports contained red flags of the company’s deteriorating financial health that were apparent to the smart money. Some long funds cut their holdings and hedge funds took large short positions, as my colleague Chris Bryant points out.
If the evidence was there to those who looked hard, it’s odd that the company was given a clean bill of health from accountancy firm KPMG months before it went bust. The impression is that auditors are on the side of the company rather than the shareholder. (KPMG says it believes it conducted its audit appropriately.)
Would more competition have made a difference? Companies may have only one accountant available if the few competing firms are already working for a rival. A lack of choice in any market usually leads to lower quality.
One response would be to force the Big Four to shed clients to mid-tier firms, creating a Big Five or Big Six. The risk is this greater competition just leads to a race to the bottom on fees with no improvement in quality. Other remedies are needed first.
The combination of audit and more lucrative consultancy work has long been chided – with good reason. Consultancy creates a client-pleasing culture. That’s at odds with the auditor’s role in challenging the assumptions behind company statements.
Opponents of a separation say combining the two services helps attract talent. This is a weak argument. Further lowering the current cap on consultancy fees, or completely separating audit and consultancy, is hard to argue with.
The accountancy firm should clearly serve the non-executive directors on the company’s audit committee which, in turn, is charged with looking out for shareholders. The risk is that the auditor’s main point of contact is the executive in the form of the chief financial officer.
Shareholders already have a vote on the appointment of the auditor. But annual reports could provide more useful disclosure on the frequency and depth of the last year’s contact between the firm and the audit committee, and between the latter and shareholders.
Now consider the nature of the job itself. Companies present the accounts, auditors check them. Out pops a financial statement that gives the false impression of extreme precision. Numbers that are the based on assumptions might be better presented as a range, accompanied by a critique of the judgments applied by the company.
Creating more big audit firms may create upward pressure on quality. But so long as they aren’t incentivized to have shareholders front of mind, it won’t be a long wait for the next Carillion.
Les études montrent que ces types d’arrangements ne sont pas immanquablement dommageables pour les actionnaires, comme nous laissent croire plusieurs groupes d’intérêt tels que le Conseil des investisseurs institutionnels et la firme de conseil Institutional Shareholder Services (« ISS »). Plusieurs militent en faveur d’une durée limitée pour de telles émissions d’actions.
Les récentes émissions d’actions à classes multiples des entreprises de haute technologie ne nous permettent pas, à ce stade-ci, de statuer sur les avantages à long terme pour les actionnaires.
In our paper, The Life-Cycle of Dual Class Firms, we consider the market valuation of dual class firms over their life cycle. Dual class financing is on the rise in recent years, particularly among high-tech firms, following Google’s seminal 2004 dual-class IPO structure. This financing choice leaves control of the firms in the hands of entrepreneurs, giving outside investors with inferior-vote shares no direct mechanism to influence the board or management. Rather, public investors buying inferior vote shares at the IPO are betting that granting the entrepreneurs such control allows them to better implement their unique vision.
However, as dual class firms mature and their vision is largely accomplished, entrepreneurs’ leadership may no longer be needed, and entrepreneurs may start self-serving behavior. Public investors’ resentment may then develop, accusing dual class firms’ controlling shareholders for wanting their money without any accountability. Such public pressure arguably recently led MSCI to issue a proposal to reduce the weight of inferior-vote shares in MSCI indices by multiplying the regular weight by the shares fractional voting power. Notably, the same MSCI also issued a report a few months ago stating that “[o]ur research shows that unequal voting stocks in aggregate outperformed the market over the period from November 2007 to August 2017, and that excluding them from market indexes would have reduced the indexes’ total returns by approximately 30 basis points per year over our sample period.” Obviously, confusion reigns over the merits of dual class financing.
Bebchuk and Kastiel (2017) (The Untenable Case for Perpetual Dual-Class Stock, Virginia Law Review) argue that any initial benefits of dual class structures decay with firm age, while the potential agency costs associated with dual class structures increase with time. Thus, Professors Bebchuk and Kastiel advocate sunset clauses to dual class financing. The sunset clauses would require the “non-interested” public shareholders of the firm to vote on whether or not to extend the dual class structure, some pre-determined number of years after the IPO. If the extension proposal is declined, firms would unify the low- and high-vote shares, i.e., convert all shares into a single class of shares with “one share one vote”.
In our paper, we empirically investigate the desirability of sunset provisions by examining the life-cycle of dual class firms. Using an extensive sample of all single-and dual-class firm IPOs in the U.S. during 1980-2015, and relying on comparing dual class firms to similar single class firms, we document several novel phenomena in the life cycle of dual class firms.
First, the difference in firm valuation between dual and single class firms strongly varies over the corporate life cycle. At the IPO, dual class firms tend to have higher valuations, as at the IPO year-end the market valuation of dual class firms is, on average, 11% higher than that of matched single class firms. This initial valuation premium of dual class firms dissipates in the years after the IPO, and on average it becomes insignificantly negative about six to nine years after the IPO. We also find that the difference between the voting and equity stakes of the controlling shareholders of dual class firms (the “wedge”) tends to increase as the firm ages. According to one of our estimates, the mean wedge increases from 16% one year after the IPO to 22% five years after the IPO, and to 26% nine years after the IPO. The widening of the wedge is typically associated with more severe valuation reducing agency problems—see Masulis et al. (2009) (Agency Costs and Dual-Class Companies, Journal of Finance). Bebchuk and Kastiel (2018) (The Perils of Small-Minority Controllers, forthcoming Georgetown Law Review) analyze the perils of the widening wedges and advocate informing the public and capping it.
Second, we document interesting differences between dual class firms with a valuation premium (relative to their matched single class firms) at the IPO and dual class firms with a valuation discount at the IPO. Dual class firms with a valuation premium at the end of their IPO year gradually tend to lose this premium, until their valuations become very similar to those of their single class counterparts about six to nine years after the IPO. In contrast, we find no evidence for a life cycle in the relative valuation of initially discounted dual class firms, as their valuation discount persists from the time of their IPO to when they are mature dual class firms as well. The behavior of the subsample of dual class firms with a valuation premium at the IPO suggests that for some firms the dual class structure does not harm valuations, at least in the first decade after the IPO. On the other hand, the behavior of the subsample of dual class firms with an initial valuation discount, which we find is highly persistent, suggests that a mandatory sunset provision may be useful for these firms.
Third, a natural solution to possible dual class inefficiency is a voluntary firm-initiated dual class share unification, in which all share classes are transformed into “one share one vote”. We find that only about 20% of dual class firms unify their shares within 9 years after the IPO. Furthermore, voluntary unifications become rare after six years following the IPO. Most of the mature dual class firms elect to retain a dual class structure, perhaps because unification is against the interests of their controlling shareholders. This implies that some inefficient dual class structures may persist.
Our findings suggest that some sort of a sunset provision might be useful, especially for firms that trade at a valuation discount. Further, regarding the set-in time of any sunset provision, our study suggests to wait at least six years after the IPO. Regulators should also be worried about some potential negative consequences of any sunset regulation. First, some founders may be more reluctant to issue publicly traded shares if their reign over the firm is likely to be more limited in time. Public may lose the opportunity to invest in some breakthrough firms. Second, controlling shareholders may intensify their private benefits extraction in the period before their extra power expires. Third, it is possible that shareholders may elect to abolish dual class structures even when they are (still) beneficial.
Finally, our paper also documents several other interesting life cycle phenomena of dual class firms such as their higher survival rates, similar stock returns and lower likelihoods of being taken over, compared to matched single class firms. We conclude that unequal vote structures are viable financing tools.
The complete paper is available for download here.
________________________________________
*Martijn Cremers* is Bernard J. Hank Professor of Finance at University of Notre Dame Mendoza College of Business, and an ECGI research member; Beni Lauterbach is a Professor of Finance and the Raymond Ackerman Family Chair in Corporate Governance at Bar Ilan University Graduate School of Business Administration, and an ECGI research member; Anete Pajuste is an Associate Professor of Finance and Head of Accounting and Finance Department at the Stockholm School of Economics, and an ECGI research member. This post is based on their recent paper.
Gouvernance | Jacques Grisé 