Volatile voting rights issue puts investors, management at odds
Snap Inc.'s high-profile listing in March of shares without voting rights has brought to a boil a simmering corporate governance standoff — between big investors increasingly focused on “engaging” with the companies in their portfolios and high-tech firms intent on limiting such engagement.
It remains to be seen whether the Los Angeles-based company behind the Snapchat image messaging app will ultimately prove a harbinger of more such listings or a cautionary tale.
For now, a building backlash — led by benchmark index providers — against Snap's extreme departure from the corporate governance “one share, one vote” gold standard looks set to discourage would-be imitators.
FTSE Russell, on July 26, led the way, announcing that companies — such as Snap — that don't have more than 5% of their voting rights in the hands of “unrestricted (free-float) shareholders” will be excluded from its indexes.
Five days later, S&P Dow Jones Indices went a step further, announcing it no longer will add companies coming to market with dual-class share structures to its widely followed S&P 500 index or the company's other U.S. benchmark indexes.
Market veterans predict those moves could blunt recent momentum that had seen one high-profile tech firm after another coming to market with share structures favoring company founders.
“Index inclusion is an important feature of going public,” with companies structuring themselves to ensure they'll be eligible, said Thomas Vita, a London-based partner with law firm Norton Rose Fulbright LLP. For such companies, the prospect of being cut off from the large and growing pool of money tracking benchmark indexes would be a “serious consideration,” he said.
Still, other market dynamics remain in play that could pave the way for more dual-class listings around the globe.
Among them, money managers point to moves now by stock exchanges in Singapore, Hong Kong and London to consider allowing dual-class shares in order to compete for high-profile tech listings globally — particularly from China — at a time when the number of firms coming to market has continued to fall.
On July 28, the Singapore exchange took a half-step in that direction, clarifying that existing rules allow dual-class share companies with primary listings on developed market exchanges to pursue secondary listings in Singapore. In a statement, Tan Boon Gin, CEO of Singapore Exchange Regulation, warned observers not to conclude that Singapore will “adopt a primary dual-class share listing framework.” The exchange is still evaluating feedback on that topic and will look “to update the market before the year-end,” he said.
Money managers say the tug of war over voting rights cuts to the core of governance.
“The idea of investor stewardship is premised on all shareholders being equal, and our voice, our vote, being proportional to our economic interest and cash flow rights in the company,” noted Jenn-Hui Tan, Singapore-based director of corporate finance with Fidelity International in the Asia-Pacific region, in a recent interview.
Breaking “that link, that 'one share, one vote' principal,” opens the door for potential misalignment of interests, said Mr. Tan.
Some observers predict there's a limit to how wide the corporate governance gulf between investors and companies can become.
Investors are focusing more and more on being “active owners of companies” even as an important, growing segment of the market is “systematically” denying them voting rights, noted David A. Smith, Singapore-based head of corporate governance with Aberdeen Asset Management Asia Ltd. “Something's got to give.”
For investors who have watched uncomfortably as the number of companies offering their founders 10 votes per share to one vote for public investors has grown, the Snap IPO effectively served as a poke in the eye with a sharp stick.
A wave of unequal voting structures in the tech sector — including Google parent Alphabet Inc., TripAdvisor Inc., Facebook Inc., Expedia Inc. and Groupon Inc. — stoked concerns that multiple share classes “was becoming conventional wisdom,” and then “Snap went a step further — a huge, high-profile IPO with no voting rights for public investors,” said John Roe, managing director, head of analytics with Rockville, Md.-based Institutional Shareholder Services Inc.
'Raised the profile'
Shares without full voting rights have been around for a while, but the Snap listing “raised the profile of the issue,” driving home the trend, agreed Matthew Filosa, vice president, director of corporate governance and proxy voting with Boston-based MFS Investment Management.
And Snap didn't seem to get much in the way of extra insulation from shareholders in return for its corporate governance notoriety.
Snap took the trend pushed forward by the likes of Google and Facebook to its “logical extreme, but once you have dominant control, whether it's based on a five-, 10- or 20-times (voting) multiple, or no vote at all, the practical implication from an investing perspective is the same,” noted Fidelity's Mr. Tan.
Some say a distinction can still be made.
“Other companies have effectively just as much control but continue the facade that investors have some say, and from a public appearance perspective they do,” said ISS' Mr. Roe. “Even with one vote per share, investors at Facebook and similar companies can express displeasure over executive compensation, director elections and more.”
A “protest vote” can still be significant, agreed Norton Rose Fulbright's Mr. Vita. “If 95% of your 5% free-float votes against something you're doing, that would be pretty hard for a company's independent directors to ignore,” he said.
As fate would have it, Snap's almost five-month stay on the New York Stock Exchange has been marked by a brief, bullish start followed by a brutal, grinding decline, with the company's share price dropping to an Aug. close of $12.93 from a closing high of $27.09 the day after its debut.
Over the same period, the S&P 500 climbed to 2,472.16 from 2,381.92.
A host of fundamental factors contributed to the decline in Snap's share price — including a worse-than-expected $2.2 billion loss for its first quarterly earnings report on May 11, fears of growing competition from Facebook's Instagram and a report by an analyst at Morgan Stanley (MS) & Co., a lead underwriter of the Snap IPO, cutting the company's rating for the stock to market weight from a “buy.” Against that backdrop, market watchers said it's hard to determine if Snap is suffering a corporate governance overhang as well.
The company's prospectus noted the possibility that Snap's decision to offer shares with no voting rights could have “adverse consequences.” Snap's press office didn't respond to requests to speak with founder and CEO Evan Spiegel.
A bit of schadenfreude
The head of corporate governance for one European money manager, who declined to be identified, admitted to being “quite happy” Snap hasn't enjoyed a huge success so far, in light of its shareholding structure. However, for the longer term, a decision by benchmark providers to exclude Snap's shares from their indexes could leave a more lasting cloud hanging over the company's stock, he said.
Putting a company like that in an index — which would leave passive investors no options to select out of specific stocks — amounts to giving management a “blank check,” he said.
Ian Burger, head of corporate governance with London-based Newton Investment Management, suggested index providers set up a “disenfranchised index,” for companies looking to tap public money while not willing to give investors full voting rights. From a good governance perspective, putting such companies in the main index would be “detrimental to the reputation of the market,” he said.
Still, a number of market veterans warned against exclusion, noting companies with dual-class shares aren't all alike, making it unwise for passive and active investors alike to rule them out across the board.
Investors cited Warren Buffett's Berkshire Hathaway Inc., another company with dual-class shares, as Exhibit A for that argument.
“We definitely prefer to have equal voting rights (but) the quality of management comes first,” said Geoffrey Wong, a Singapore-based managing director with UBS Asset Management, as well as the firm's Asia Pacific head of global emerging markets and equities.
“Being discriminated against on voting rights is a meaningful issue but for us it's not a deal breaker,” he said, noting “not many people complain about the governance” at Berkshire.
“If you decided not to buy Berkshire Hathaway in 1965, you missed out on a lot of value for your clients,” agreed MFS' Mr. Filosa.
Fidelity's Mr. Tan expressed sympathy for passive investors pressuring index providers to look after their interests by doing “the stock selection, essentially, for them,” but he went on to ask if that's the role index providers should be playing. “Or is this the role of an asset manager,” he asked.
One of the largest managers of passive assets, Boston-based State Street Global Advisors, appears to agree. “Our view is that providers like MSCI and FTSE are supposed to provide an index that's representative of the entire investible market,” said Lynn Blake, SSGA's chief investment officer of global equity beta strategies, in a recent interview.
In a July 5 posting on the Harvard Law School Forum on Corporate Governance and Financial Regulation, Ethan A. Klingsberg, a New York-based partner with Cleary Gottlieb Steen & Hamilton LLP, warned that excluding Snap on account of its share structure could mark a “turning point” that leaves index providers as the central players on the “governance battlefield,” rather than the investors buying and selling a company's shares in the market. He didn't respond to emails seeking further comment.
FTSE Russell, in a paper about its voting rights conclusions posted on its website, painted its 5% threshold as a compromise for the roughly two-thirds of its clients “that believe the Snap Inc. IPO set a dangerous precedent” and the remaining third looking for index providers to “represent the investible opportunity set as comprehensively as possible.”
That low hurdle will discourage future IPOs with “few if any voting rights,” without pulling the rug out from existing index heavyweights with “differential voting rights” such as Alphabet and Facebook, effectively drawing “a principled line in the sand,” according to FTSE Russell's paper.
Some money managers said they're skeptical regulators will prove especially helpful in the near term. With the political winds now blowing in the U.S., a “corporate-centric model” could gain ground against a “shareholder-centric model,” providing continued momentum for dual-class share structures, predicted MFS' Mr. Filosa.
“We're quite likely” to see companies continue to come to market with dual-class shares, agreed UBS' Mr. Wong.
Especially so if stock exchanges in Singapore and Hong Kong respond to their “prisoners' dilemma” by allowing departures from “one share, one vote.” That could set off a domino effect, at the end of which “no one's better off, no one has an advantage and the only ones worse off are us and our clients,” said Aberdeen's Mr. Smith.