On March 28, 2019 the Nasdaq Listing Council invited me to respond to the recent proposal by the Council of Institutional Investors (“CII”) to Nasdaq, requesting it to adopt a rule requiring any company going public with dual class shares to include a mandatory “sunset” provision in the company’s charter. CII’s proposal would provide that after seven years the company’s stock would automatically convert into a single class unless the stockholders, voting separately as a class, approved extending the dual class listing. Nasdaq’s Listing Council also invited Barbara Novick of Blackrock to speak on behalf of CII’s Petition.
My response focused on three issues. First, I discussed what I believe is the real issue raised by dual class stock: Who gets to select a company’s directors? This is the critical issue because under Delaware law (and the law of most states) the corporate republic is not a direct democracy. Simply put, corporations are managed by their boards of directors, not stockholders. However because stockholders are the only parties currently entitled to vote for directors, and for most of the last 40 years most public (but not private) corporations have operated under the “one share/one vote” system of governance, directors have become primarily responsive to the interests of stockholders.
Recent changes to our capital markets, including the increased concentration of ownership of public equities in the hands of a few large institutional investors, means that elections for public company directors are now determined by a small number of institutional investors and activist funds. Private companies considering going public are well aware of this dynamic, and recognize that if they choose the “one share/one vote” method of governance the practical reality is that within a few years the company’s directors will be selected entirely by these institutional investors and activist funds.
Many of our most innovative and entrepreneurial leaders, as well as the venture funds and other investors who helped grow these companies, believe that allowing the board to be selected entirely by large institutional investors and activist funds is a less than optimal solution. Not surprisingly then, these leaders and other early investors who helped build our leading new companies have looked to other structures to govern the company as it transitions to having its stock publicly traded. Given the limited options available, it is also not surprising that dual class stock is considered a reasonable alternative to the dominant “one share/one vote” ideology supported by CII.
Second, but equally important, CII’s proposal for a “one size fits all” regulatory approach of corporate governance is not supported by the empirical data. CII’s petition claims that “[r]ecent academic evidence suggests that the real problems with unequal voting rights develop in the medium to longer term,” and that “academic research and developing market practice suggest” a “sunset of no more than seven years” offers an appropriate compromise. CII’s interpretation of the empirical evidence is not correct. Specifically, while CII cites numerous studies to support its conclusion, these studies are both flawed and do not support CII’s position. In fact, the most recent review of the literature by two prominent academics concludes that “compulsory sunsets, and time-based sunsets in particular, are an inappropriate response to the potential problems of dual class stock.”
The other studies, including many of the same studies cited by CII, confirm this reality. For example, several recent empirical studies show that dual class companies have out-performed their single class peers for at least a decade. Further, many of these studies do not include performance data from some very successful technology companies that are the focus of CII’s proposal but have not been public long enough to be included in any of these studies.
More broadly, and even more significantly for policy makers such as Nasdaq, other exchanges and the SEC, recent studies support what I (and I suspect many corporate law practitioners) have long recognized: that there is little correlation between so-called “best governance practices” and either corporate performance or corporate governance. As one corporate law scholar recently recognized, the “reality is governance rankings measure only adherence to ‘best practices’ and this is something completely different than measuring integrity or business success. On the evidence available to us, best practices are not predictive of these latter virtues.” In short, the increasing adherence to so-called “best governance practices” resulting from the growing power of institutional investors and activist funds is not correlated with better corporate governance, more ethical behavior, or better corporate performance.
I conclude my talk by offering some compromise proposals directly to CII and other institutional investors that I believe could better achieve their goals of fostering better governance while also opening up the process for director selection. While my proposals have not been empirically tested (and some may be contrary to long-held views by some CII members) I remain confident that there is ample room for discussion as we all share the same ultimate goals of creating more ethical and better-governed companies that achieve greater success for all corporate stakeholders. Further, like CII I believe the exchanges can and should continue to play their historic role as facilitators, conveners, and contributors to this debate, and I am delighted to take part in this discussion with the Nasdaq Listing Council.
This post comes to us from David Berger, a partner at the law firm of Wilson, Sonsini, Goodrich & Rosati and a senior fellow at NYU’s Institute of Corporate Governance & Finance. It is based on his remarks on March 28, 2019, to the Nasdaq Listing Council, which are available here.