The vast majority of U.S. companies list a single class of stock that carries one vote per share and pegs an institutional investor's voting power to its at-risk capital. But some entrepreneurs, especially in Silicon Valley, while they sell the lion's share of the stock in their companies, they also maintain sufficient shares to control board elections and votes on other proxy proposals. Or they issue stock with dual- or multiple-class structures, holding the shares with greater voting power to stay in command.
Supporters of closely controlled company structures — especially those with dual- or multiclass unequal voting schemes — argue that control of a firm's voting power enables management teams to minimize the impact of short-term market pressure and to focus on long-term business prospects.
Shareholder critics often decry their disenfranchisement or marginalization, particularly when faced with contentious proxy ballot measures, with some investors seeking to dismantle such structures. ISS is currently tracking 10 shareholder proposals requesting that firms with dual-class stock structures adopt a “one-share, one-vote” policy. ISS' policy is to generally support such proposals, although none opposed by the board has ever passed, which is not surprising given that vote outcomes at controlled companies are most often pre-determined. Even so, 2015 witnessed the highest level of average shareholder support (34.9%) for proposals seeking to dismantle dual-class stock structures since 2009. As a result, investors and other observers will be watching support levels closely this proxy season.
When defending controlled company structures, founders or other controlling shareholders often promise higher returns over time in exchange for public shareholders' limited rights. To test the likelihood that such promises will be kept, ISS recently completed a study of controlled companies in the Standard & Poor's 1500 universe on behalf of the Investor Responsibility Research Center Institute. Notably, the study findings challenge the notion that controlled companies, and those with multiclass voting structures in particular, are inherently beneficial to the firms and their shareowners over the long run.
Among the findings:
nControlled companies underperformed their non-controlled counterparts over all periods reviewed (the one-, three-, five- and 10-year periods ended Dec. 14, 2015) with respect to total shareholder returns, revenue growth, return on equity and dividend payout ratios. Controlled companies did manage to outperform non-controlled firms with respect to return on assets. Results for returns on invested capital were mixed: controlled companies outperformed marginally (by less than a percentage point) for most time periods, but underperformed over the 10-year period.
nMost-recent-fiscal-year-average CEO pay at multiclass-stock-controlled firms significantly outstrips that at both non-controlled companies and controlled entities with a single class of stock. Average CEO pay at controlled companies with a multiclass capital structure is three times higher than that at single-class stock controlled firms and more than 40% higher than average CEO pay at non-controlled companies.
nAs of the 2015 annual meetings for companies studied, women and minority directors are less common at controlled companies compared with non-controlled firms. The proportion of controlled companies with no female representation on their boards is almost 4 percentage points higher than at non-controlled firms, and the percentage of firms with two women on the board is 9 percentage points lower. The prevalence of controlled firms with no minority representation on the board is 20 percentage points higher than at non-controlled companies, and the proportion of firms with two minorities on the board is lower by more than 7 percentage points.
nBoard tenures are generally lengthier at controlled companies compared with non-controlled firms. As of the 2015 annual meetings for companies studied, the proportion of controlled firms where board members average at least 15 years of board service is more than 17 percentage points higher than at non-controlled firms. The rate of board seat refreshment at controlled entities is lower than at non-controlled companies; almost 80% of controlled firms have no new nominees on their board, roughly 10 percentage points higher than at non-controlled companies.
While controlled companies remain rare — representing just 7% of S&P 1500 index constituents and 10% of the index's market capitalization — they are casting a wider shadow across many institutional investors' portfolios and increasing exposure to associated market risks. Given that traditional remedies and oversight mechanisms are unavailable when things go awry, investors should consider whether such risks are worth taking, carefully assess the merits of new classes of common stock, and evaluate the particulars of control mechanisms/controlling entities at controlled companies when making their investment decisions. n
