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  • Share Class Shenanigans:Google, News Corp, Emmis, And Other Companies To Watch Out For

    Beth Young, J.D., Senior Research Associate
    Kimberly Gladman, CFA, Ph.D., Director of Research and Risk Analytics

    Executive Summary

    Recent issues related to dual share classes with disparate voting rights have sparked controversy at Google, News Corp, and perhaps most dramatically, radio broadcaster Emmis Communications. These examples demonstrate the dangers to investors that result when voting power does not align with economic interest-a risk indicator GMI Ratings has identified at over 200 publicly traded companies in the Russell 3000.

    Dual Share Classes and Governance Risk

    Recently, both Google and News Corp have been in the news for issues related to dual share classes with disparate voting rights. Google has announced that as part of a stock split, it will issue a new class of stock that has no voting rights for current shareholders. The plan will further solidify the power of the company's leadership, which already controls two-thirds of the voting power through special Class B shares. At News Corp, meanwhile, non-US domiciled Class B shareholders have recently seen their voting power reduced as a means of remedying the company's non-compliance with US regulations on foreign ownership of broadcasters. This step has relatively minor impact on voting at the company, since the Murdoch family already determines the outcome of any matter through its ownership of 40% of the voting stock.

    At GMI Ratings, we have long collected data on companies that have dual share classes with disparate voting rights. The disjunction between economic interest and voting power that results from such arrangements, we believe, can pose a serious risk to a company's public shareholders. While this may sometimes seem like a merely theoretical concern, these recent high-profile cases are bringing more attention to the issue. It is at a much smaller firm, however, that some truly elaborate maneuverings are being facilitated by a dual-class capital structure: Emmis Communications.

    The Emmis Imbroglio

    It's not often that events at one company involve as many hot-button corporate governance issues as the imbroglio at radio broadcaster Emmis Communications [NASD:EMMS]. Emmis' CEO and controlling shareholder Jeffrey Smulyan, who led a failed management buyout (MBO) effort in 2010, is using complex derivative transactions and his common stock voting control-which he enjoys as a result of a dual-class share structure-to bring about a major restructuring. The situation highlights the risks of excessive management entrenchment and illustrates the need for state corporate law to catch up with evolving forms of ownership and control.

    Over the past several years, companies and their advisors have repeatedly sounded the alarm over "empty voting." Accomplished through various means, including share lending and swap agreements, empty voting occurs when someone who does not own outright shares of a company's stock has the ability to control voting of those shares. Put another way, empty voting involves separating economic interest and voting rights.

    Shareholders-more specifically, hedge funds-are generally viewed as the perpetrators of empty voting. A 2010 article in Institutional Investor described empty voting as "a practice favored by some activist hedge funds to boost their voting power without putting up much money." As a result, empty voting has been cited as a reason to be cautious about corporate governance reforms that would increase shareholder power.

    But it turns out that not all companies deplore empty voting. In a surprising twist on the usual story, Emmis is planning to use empty voting techniques against its own preferred shareholders. Those with the most to lose if Emmis succeeds are hedge funds that own the company's preferred stock.

    Emmis badly wants to restructure its obligations to its preferred shareholders. Because it has not paid a preferred stock dividend since October 2008, Emmis owes those holders $21 million to which they are contractually entitled. Emmis would like for those unpaid dividends to be forgiven and for Emmis to be released from its obligation to pay dividends in the future.

    Emmis is in a jam with its stock exchange regulator as well: Nasdaq has threatened to delist its common stock for non-compliance with the $1.00 minimum bid price requirement. Emmis has requested a hearing where it intends to present a plan to raise its stock price above the $1.00 minimum. Reducing its obligations to its preferred shareholders would be a useful element of such a plan. (Emmis is also seeking approval for a reverse stock split.)

    What's more, any major transaction, like the MBO Smulyan tried to lead in 2010, now requires separate approval of two-thirds of preferred shares; in 2010, preferred shareholders blocked the deal. Emmis wants to eliminate preferred shareholders' right to vote separately on control transactions and to demand repurchase of their shares if a going-private transaction involving Smulyan that does not qualify as a change of control occurs. Smulyan has said he is not currently planning to propose another MBO. But removing the preferred shareholders as an impediment would benefit Smulyan should such an opportunity arise down the road.

    The challenge for Emmis is that changes to the preferred stock's terms must be approved by holders of two-thirds of preferred shares. The changes Emmis wants to make have been estimated to reduce to approximately $2 the value of shares that originally sold for $50 in 1999. So Emmis figured out a way to become one of its own major preferred shareholders and consent to the changes.

    In November 2011, Emmis entered into a total return swap covering over a million shares of Emmis preferred stock owned by Alden Global Capital, a fund that had agreed to finance the failed 2010 MBO and with which Emmis and Smulyan had been embroiled in litigation. A total return swap shifts the economic risk associated with owning an asset (here, the Emmis preferred stock) from the legal owner of the shares (the "payor," here Alden) to another party (the "receiver," here Emmis). Generally speaking, the payor makes periodic payments to the receiver representing the economic impact of owning the security. In the case of preferred stock, those payments would likely include dividends and changes in the value of the shares. (Emmis has not disclosed all the terms of the total return swap agreements into which it entered.)

    Emmis also entered into a voting rights agreement with Alden providing that Emmis has the right to direct voting of the shares. Immediately following the transaction with Alden, Emmis had the right to direct voting of over 56.8% of its own preferred stock. (By an April 2, 2012 special meeting of shareholders, that proportion had increased to 61.3%.) Through these transactions, Emmis acquired all the rights and risks of ownership of a majority of its own preferred stock without actually becoming legal owner of the shares.

    So why didn't Emmis simply buy the shares back from Alden and the other holders? The likely answer to that question is that Emmis needed to sidestep provisions of Indiana corporate law that prevent a company from voting shares that it has repurchased; if Emmis had bought back its preferred stock, Indiana law would have counted the stock as "authorized but unissued" which would mean it could not be voted.

    Because Emmis, even after the total return swaps, did not control the two-thirds of shares necessary to change the preferred stock's terms, it engaged in another questionable transaction. At an April 2, 2012 shareholder meeting, common shareholders approved a proposal to issue 400,000 shares of preferred stock to a "retention plan," pursuant to which employees can receive awards of preferred stock. The earliest any grantee will actually obtain shares is April 2, 2014, however; until that time, the preferred shares in the retention plan are voted by the trustee, who is Smulyan. With the retention plan shares, Emmis (i.e.,Smulyan) controls the voting of 66.8% of preferred shares, enough to approve changes to the preferred stock up for a vote at a special meeting of shareholders, the date for which has not yet been set.

    The issuance of shares into friendly hands such as an employee compensation vehicle helmed by management in order to disenfranchise existing holders is frowned upon by institutional shareholders, who typically will not vote in favor of such arrangements. Even though common shareholders won't be harmed directly by the changes to Emmis' preferred stock, they might oppose those changes on principle or because they fear Emmis' cost of capital might increase as a result of its conduct. They might also be leery of paving the way for an MBO in which Smulyan could benefit at the expense of other common shareholders. But those concerns don't matter: approval of the proposal creating the retention plan was a foregone conclusion since Smulyan has voting control over Emmis' common stock via a dual-class share structure in which Smulyan owns all of the supervoting shares. Those who pooh-pooh warnings about the dangers of dual-class structures should take note.

    Emmis has sued several hedge funds that are working together to resist the restructuring, seeking a ruling that its strategy is legal. (The shareholders have countersued, alleging that it is not.) If Emmis' strategy is upheld, it could set a precedent allowing companies to make an end run around rules designed to prevent companies from voting their own shares and disenfranchising shareholders. Ironically, companies concerned about empty voting by shareholders will be undercut if Emmis is successful in convincing a court that form should prevail over substance.

    Dual-Class Companies to Watch Out For

    The following are some S&P 500 companies where dual-class structures with disparate voting rights strengthen the influence of particular investors-typically a founding family or other dominant shareholder.

    Aflac Incorporated
    Apollo Group, Inc.
    Berkshire Hathaway Inc.
    Broadcom Corporation
    Cablevision Systems Corporation
    CBS Corporation
    CME Group Inc.
    Comcast Corporation
    Constellation Brands, Inc.
    Discovery Communications, Inc.
    Estee Lauder
    Expedia, Inc.
    Federated Investors, Inc.
    Ford Motor Company
    Google Inc.
    Hershey Company (The)
    Lennar Corporation
    Molex Incorporated
    News Corporation
    Ralph Lauren Corporation
    Scripps Networks Interactive, Inc.
    Simon Property Group, Inc.
    Tyson Foods, Inc.
    United Parcel Service, Inc.
    Visa Inc.
    Washington Post Company (The)

    May 03 10:30 AM | Link | Comment!
  • Climate Economics: ESG Matters

    By Robert A.G. Monks, J.D., Co-Founder GMI Ratings, Kimberly Gladman, CFA, Ph.D., Director of Research and Risk Analytics

    Financial professionals reading in the media about climate change may think of it as a scientific issue, unconnected to their day-to-day work. In fact, however, over the last few decades climate change has been studied extensively not only by scientists but also by economists, who have quantified its potential effects in monetary terms. Using a number of techniques also used in portfolio management, their models account for risk and uncertainty, and estimate a range of possible outcomes. Their work demonstrates that climate change is virtually certain to have a significant impact on GDP around the world-and consequently also on investment markets.

    One of the main tools of climate economics is Integrated Assessment Modeling (IAM). Because climate will affect the economy in many different ways, Integrated Assessment Models combine a variety of methodologies. At the simplest level, they examine effects on economic sectors for which prices already exist or can be fairly easily calculated, such as agriculture, energy use, and forestry. They also estimate effects-both positive and negative-on industries like fishing, construction, and outdoor recreation.

    Next, IAMs address factors for which a monetary value must be estimated, such as increased mortality from climate-related diseases and pollution. Techniques for valuing human life and health sometimes start from an established economic technique called "willingness to pay" (WTP), which estimates what people are typically willing to spend to avoid or decrease risks of various kinds. However, because individuals' WTP can vary with their overall level of wealth, the models are often adjusted to ensure that lives in low-income and high-income countries are valued equally.

    Even the most comprehensive current models, however, likely underestimate the economic impacts of climate change because they omit the effects of broad societal responses to it, such as political conflict (e.g., over water rights), migration (e.g., of refugees from flooded or drought-stricken areas), and the flight of capital investment from badly-affected regions or industries.

    Many older IAMs assumed climate change would progress gradually. However, the more sophisticated recent models incorporate the fact that climate change increases the likelihood of extreme weather events, and that temperature rises may produce intensifying feedback loops (e.g., if permafrost melts and the methane it contains is released). Some of these models, such as the one used by the Stern report produced by the UK government several years ago, address these possibilities by using Monte Carlo simulation, which is also used in financial modeling. Given a predetermined range of possible parameters, this technique chooses random values for each of many model runs, generating a probability distribution of results rather than a single estimate. Across this distribution, the net costs of climate-related damage and adaptation costs are subtracted from a baseline projection of the GDP growth that would occur without climate impacts.

    The results of IAMs naturally vary depending on their individual assumptions and methodological differences. However, taken together, the leading models suggest that climate change may already be reducing global GDP by at least 5%, and that this dampening effect could increase to as much as 20%. Moreover, emerging market economies are expected to be hardest hit, due to factors including disadvantageous geography, more fragile infrastructure, and a lack of resources to devote to disaster recovery or adaptation. This is especially concerning news for investors who are looking to emerging markets to fuel the world's economic engine in the coming decades, particularly as growth slows in the highly leveraged economies of Europe and the US.

    Investment Analysis

    Since macroeconomic developments of this scale are likely to impact nearly all portfolios in some way, many investors are examining the climate impact of the companies in which they invest. Some investors are building climate effects into their macroeconomic assumptions; others seek to invest in companies with lower climate impacts, assuming that regulators will eventually compel companies to internalize climate-related costs.

    A principal way companies contribute to climate change is through their emissions of heat-trapping greenhouse gases (GHGs), which include methane, nitrous oxide and carbon dioxide. In order to compare the warming effects of different GHGs, they are frequently converted into their equivalents in terms of carbon dioxide (often referred to simply as "carbon"). A summary number can thus be produced which expresses a company's overall GHG impact in terms of carbon emissions.

    At GMI Ratings, we include carbon dioxide intensity data sourced from Trucost, a specialist environmental research firm. The Trucost carbon intensity ratio estimates the quantity of a company's carbon emissions per million dollars of revenue. It can thus be used to make an apples-to-apples comparison between companies, and to show which are producing sales the most (or the least) efficiently in carbon terms. Carbon intensity is one of the Key Metrics on which our ratings are based, and it is flagged for any company whose carbon intensity is in the top 10% of its sector peer group. We also display in each of our company products the sector average for this metric in comparison to a market benchmark, so that clients can identify those sectors (e.g., utilities, coal, or oil and gas) with particularly high carbon intensity.

    Sample Companies

    A selection of companies that are flagged for carbon intensity because they rank in the highest 10% of their sector peers on this metric as of April 2012 is given below.







    Bayer AG




    Western Europe

    Pharmaceuticals - Diversified

    Boston Scientific Corporation




    North America

    Advanced Medical Equipment

    Darden Restaurants, Inc.




    North America


    Eli Lilly & Co.




    North America

    Pharmaceuticals - Diversified

    Gecina SA




    Western Europe

    REIT - Residential / Commercial

    MGM Resorts International




    North America

    Casinos / Gaming

    Owens Corning




    North America

    Construction - Supplies / Fixtures

    Tate & Lyle PLC




    Western Europe

    Food Processing

    TUI AG




    Western Europe

    Leisure / Recreation

    United Microelectronics Corp.




    All Other


    Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

    Apr 25 9:52 AM | Link | Comment!
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