By Michelle Lamb - Senior Research Associate, GMI Ratings
Shareholders have long been concerned about multiple classes of stock with disparate voting rights since such a structure divorces decision-making power from financial exposure. Despite this, recent social media company IPOs have chosen to have two or sometimes three classes of common stock with different voting power and it appears many are currently suffering in the marketplace.
As Nell Minow recently explained, "[t]he essential principle at the core of capitalism is the assurance that investors' money will be honorably managed by the corporate executives. That means if their interests are mis-aligned, the shareholders can replace managers with better ones. That cannot happen if the insiders control the voting stock." Studies have shown the presence of dual classes of stock reduces investment by institutional investors, and has become a risk factor in many corporate governance screens, including ours at GMI Ratings, because of its relationship to increased governance risk. Indeed, the structure is only adopted at a minority of public companies (only 40 S&P 500 and 268 Russell 3000 companies). However, several high profile companies - specifically recent social media IPOs Facebook (FB), Groupon (GRPN), LinkedIn (LNKD) and Zynga (ZNGA) - recently adopted multiple class share structures and many have since suffered major stock price declines or developed other governance concerns.
In addition, the largest and one of the most influential public pension funds, CalPERS, recently announced that it would: "Develop an IPO governance expectations document, explaining the governance expectations [it] has for public companies… [and] address core governance standards of accountability and transparency such as removing dual class, classified, or plurality voting structures." Companies with dual class share structures are under close examination and it would appear likely that CalPERS, among other large public funds, will engage privately with such firms to persuade them to remove differential voting rights and implement a one-share, one-vote structure.
Below we outline the details of these structures and the companies' recent troubles.
Pre-IPO Facebook had adopted a dual-class share structure, which many claim followed Google's (GOOG) example from 2004 with both firms giving their Class A common stock one vote per share and Class B 10 votes per share. As we recently explained in a Forbes blog, pre-IPO founder Mark Zuckerberg held "almost 57 percent of the voting power of the stock through ownership and voting power over other shareholders' stock via what is known as an irrevocable proxy. You all know what irrevocable means. So that really means that elections and any issues at the annual meeting are his to decide." The company's share price is now infamously on the decline, falling from a closing price of $38 at its May IPO to an all-time low last week around $18. The company has also made headlines for insider stock sales, and its PR struggles to defend its originally all-male board and concerns over directors' lack of independence (which included the sole female member it recently appointed, the COO Sheryl Sandberg.) GMI Ratings assigned Facebook an ESG Rating of D since its IPO.
Groupon, the e-commerce discount company, has come under fire for several reasons in the past year since its November 2011 IPO. Most recently its share price slide from IPO closing price of $26 to this week's price around $4, but also in past months for its apparent lack of financial expertise (and resultant restatements). We wrote a pieces for Forbes in April on the various board overcommitments, interlocking relationships and lack of financial expertise. Recently some of Groupon's investors, like Marc Andreesen have begun selling their shares. Again, this is a company with a multiple class share structure with the disparate voting rights favoring insiders - its Class B common stock has 150 votes per share and its Class A has one vote per share. As of December last year, the three founders (Eric Lefkofsky, Bradley Keywell and Andrew Mason) controlled 100 percent of the Class B and about 33 percent of the Class A common stock, resulting in about 57 percent of the voting power. GMI Ratings does not include Groupon in its coverage universe as of this date.
Another social media company with 1 vs 10 votes per share for their Class A vs B common stock respectively, the professional networking company LinkedIn nevertheless has a share price that has actually increased somewhat since its IPO. This may explain how it has avoided as much intense media scrutiny as its peers, however the governance concerns of such an ownership structure remain. As of their 2012 proxy, LinkedIn's "all executive officers and directors as a group" controlled 76.8 percent of the company's voting power; the largest contributors to this total include Chairman Reid Hoffman's beneficial ownership of 45.4 percent of the Class B voting power (and he controls 39.4 percent of the company's overall voting power), Sequoia Capital's 17.8 percent control (via Director Michael Moritz) and Greylock Partners' 14.9 percent of the overall voting power (via Director David Sze).
This online real estate marketplace company shares the same 1 vs 10 votes per share, dual-class ownership model. Zillow is not part of the GMI Ratings coverage universe for ESG Ratings yet, but has had an "Aggressive" AGR accounting risk rating since its IPO which has now changed to "Very Aggressive". Zillow's all-male board of directors appears to be closely associated with either Microsoft or its spin-off Expedia, the firm that purchased Zillow founder and CEO Spencer Rascoff's former company Hotwire.com in 2003. Indeed, five of the eight directors were associated with Expedia in one way or another. Included on the board is Executive Chairman Rich Barton who himself had founded Expedia and was the prior CEO of Zillow before he was succeeded by Spencer Rascoff in September 2010. The company's current AGR rating places them in the 6th percentile among all companies in North America (indicating higher governance risk than 94 percent of companies). Among its accounting red flags are its rate of Mergers and Acquisitions, and its ratio of Goodwill to Total Assets. We described the concerns related to its aggressive purchasing strategy and potential goodwill estimate revision risk in a piece here last week. As of their 2012 proxy, Directors Barton and Lloyd Fink held 56.5 and 43.5 percent of the Class B voting power, contributing to the "All executive officers and directors as a group" total of 87.5 percent of the company's voting power.
In an exceptional move, the online social gaming company Zynga created not just two classes of stock with disparate voting rights, but a third class of "supershares" wholly owned by Chairman and CEO Mark Pincus - his class enjoys 70 votes per share while the shares available to the public have only one vote per share. The other class of stock, available only to company insiders, has seven votes per share. As of their 2012 proxy filing, Mr. Pincus owned 14.6 percent of the company but controlled 37.6 percent of the vote due to his 100 percent ownership of the Class C shares. "All executive officers and directors as a group" control 45.6 percent of the voting power of the company. Zynga is among the social media companies to have seen a major share price decline since its IPO, falling from about $9 last December to around $3 this week. Zynga is not part of the GMI Ratings coverage universe as of this date.
What is now referred to as "the Zuckerberg Grip," this voting control exercised by insiders via multiple class share structures is becoming "the new normal" for tech company IPOs. Whether their governance woes and share price declines are directly related to their choice in ownership structure remains a contentious debate; we have our opinion.
(Votes per share)
Share Price at IPO
Closing Share Price 9/5/2012
Class A common (1), Class B common (10)
Class A common (1), Class B common (150)
Class A common (1), Class B common (10)
Class A common (1), Class B common (10)
Class A common (1), Class B common (7), Class C common (70)