How Much Control Do You Need?
Disclaimer: I love the concept of shareholder control so much I married it. Well, not really… But I did enact a system modeled on a market economy to give control of my romantic life to other people.
I’ve been experimenting with the idea of “shareholder control” since 2008 when I allowed my friends to vote on my personal decisions. I’ve asked them for advice on everything from buying a car to getting a vasectomy to whom I should date.
Everyone likes to control other people! Because they get to control my personal choices they develop a real relationship with me and tend to hold their positions for long periods of time as the price goes (slowly) up and down.
This experiment has given me a unique view on shareholder influence. I think of the shareholders as a benevolent force guiding me to make the right choices. That isn’t always the case for publicly traded companies.
“Greenmailing”
The rise of the corporate raider in the 1980’s displayed the power of shareholder control. “Greenmailing” involves purchasing a large enough interest in a company to propose new ideas or threaten a corporate takeover.
In the eighties Carl Icahn borrowed a bunch of money to buy TWA stock and appoint himself as chairman. Because he purchased the shares with debt, he sold company assets (like the company’s Heathrow operations) to pay it back. In the end he made millions for himself but the company ended up with massive debt and eventually filed for bankruptcy. You might remember this as basically the plot of Oliver Stone’s Wall Street.
Today many of the (in)famous corporate raiders have moved on. Others, like Carl Icahn, are still at it but now prefer the gentler role of “shareholder activists.”
Update (6/19/16): Yahoo, which in the process of selling off their core web business, is selling off its own assets. It’s breaking itself up instead of waiting for a “corporate raider” I guess?
The Shareholder Activist
Shareholder activists can be grouped into four broad categories:
- Hedge fund activism
- “Vote No” campaigns
- Shareholder proposals
- Say on pay
These categories are on a spectrum with hedge fund activism being the most aggressive and say on pay being the least aggressive.
Hedge Fund Activism
The hedge fund activists seek significant change in a company. In the 1980’s these “activists” were called Corporate Raiders as they would push for the breakup of a company after buying enough shares to take control of the board. In the 90’s the same tactic was used by new funds but they would only gain minority board representation and work to influence an agenda from within. Today smaller hedge funds will attempt to influence a company though a variety of tactics including public media campaigns.
“Vote No” Campaign
Less aggressive tactics include running a “Vote no” campaign where an investor (or a group of investors) urges the shareholders to withhold support for a particular board member. While it’s difficult to garner enough support to forcibly oust someone it’s often a signal to the company that they should voluntarily choose to replace the board member or the board member may resign. This tactic is often sponsored by pension funds.
Shareholder Proposal
A shareholder proposal is further down the spectrum and often involves attempts to change a specific governance policy, change executive compensation, change oversight of a certain functions (like an audit), or change a company’s behavior as a corporate citizen (like political spending or environmental issues).
Say on Pay
Say-on-pay, which came from a requirement for companies participating in the Troubled Asset Relief Program (TARP) in 2008 and was expanded as an SEC requirement in 2009 for all public companies, allows shareholders to vote on the compensation of executive officers at least once every three years. As a required vote it’s the least aggressive form of shareholder activism.
Shareholder Activism: Good or Bad?
Jeff Gramm, a hedge fund manager and adjunct professor at Columbia Business School, wrote a book about shareholder activism called Dear Chairman: Boardroom Battles and the Rise of Shareholder Activism. He documents the struggle between shareholders and companies that has been going on for nearly a century. In an interview about the book he remains neutral but there seems to be a theme that corporate America is not working in the best interest of shareholders.
His response is:
The bitter truth is that many, many public companies are horribly run, and that shareholders are often treated terribly. In the best of these cases we are a mere nuisance, and in the worst cases we are parties to be exploited. Not every public company is out to screw its shareholders, but I think a good value investor always needs to understand that his or her interests will never perfectly align with management’s.
Selling Shares but Maintaining Control
So what does a public company do if it wants to raise capital by selling shares but keep activist shareholders from meddling with the long term vision? They issue shares with less voting power!
My Bucket List: Own a Share of BRK.A
BRK.A is the Class A voting stock of Berkshire Hathaway, the multinational conglomerate holding company of Warren Buffet. BRK.A trades for over $200,000 (the stock has never split!) for a single share and when someone buys or sells a bunch of them it makes the news. Of course you can always buy BRK.B for just $140, but that’s no bucket list goal!
Importantly, BRK.A and BRK.B move the same way. There is a tiny difference, but it’s very tiny…
Buffet created BRK.B to torpedo the creation of exchange-traded funds by suits on Wall Street that tracked to Berkshire Hathaway but could be purchased for less money. The new Class B shares initially had 1/200 of the per-share voting rights as the Class A stock and when the stock split the per-share voting price became 1/10,000. So if you buy 10,000 BRK.B shares you have the same voting power as if you bought one BRK.A.
If you really care about voting you’re going to buy BRK.A, but if you just want to invest in the “Oracle of Omaha” you can BRK.B for increments less than $200,000. Everyone wins!
Q: What’s better than selling shares with less voting power?
A: Selling shares with NO voting power!
The Zuckerberg Strategy
Even as someone who loves the idea of shareholder control I have to hand it to Facebook. The method they are using to have their cake (money) and eat it too (control of the company) is fantastically clever.
Facebook has Class A shares that are normal and Class B shares that have 10x voting power. CEO Mark Zuckerberg owns most of the Class B shares:
Since those Class B shares have 10 times the voting power of Class A shares Zuckerberg holds 54% of the voting power of the company!
The new plan that Facebook announced is the creation of Class C shares. These will be nonvoting shares.
For every share of Class A or Class B that someone has, they’ll get 1 share of Class C. That means more shares to sell but no change in voting power if you only sell your Class C shares. That’s pretty easy to model in the spreadsheet:
After the creation of the Class C shares Zuckerberg will have like 423 million of the ClassC shares that he can sell without losing any control. Brilliant!!!
Right now Facebook is trading at $116.77. The creation of the Class C shares is effectively a 3–1 stock split. The current price divided by three is $38.92. That gives Zuckerberg more than $16 billion dollars of stock he can sell while maintaining his 54% voting control (and he can just keep splitting the stock this way forever).
The Slate Money podcast brought this up and Felix Salmon shared his nightmare scenario where Facebook’s issuing of nonvoting shares would allow Mark Zuckerberg to sell shares, raise money, and acquire all the companies while maintaining singular control of a company that owns everything. Not likely, but a fun idea. :)
As Above So Below
Felix also pointed out that buying nonvoting shares is like owning part of a private company. That reminds me of what Marcus wrote about the blending of private and public companies:
Businesses now exist somewhere along a gradient between the two poles. The more liquidity you want from the general public, the more information you disclose. And the graduation steps along the way require more modest leaps of faith.
Private companies can now be “kind of” public in the sense of raising money, and as Slate Money points out, by issuing nonvoting shares a public company can be “kind of” private in the sense of control.
This “kind of” means one publicly traded company (like Facebook) is immune to shareholder control while another is struggling against shareholder activists trying to split the company up (AIG). And a private company can now raise capital from the general public and invite them to the table, or keep them at arm’s length. Ultimately the investor decides how much control they need to feel comfortable investing. Or, more likely, someone will make that choice on the investors behalf.
Collective Power of Funds
Jeff Gramm point outs, “If more and more power accrues to index fund investors, it will be very interesting to see how they wield it from a corporate governance perspective.”
Most regular investors, especially those invested in funds, have already surrendered control of their votes. Fortune explains “If you own shares in a broker-managed account, you have most likely given up your voting rights to your broker.”
But that’s great for those (like me!) that don’t want to vote on all the proposals from all the companies in a portfolio. Using a service like Betterment means not even knowing what stocks are owned much less the best way to vote on company issues. Betterment chooses the best investments and also chooses the best way to vote.
Virtual Private Funds
This is where Chroma.fund steps in! We provide the same collective power of a traditional fund but apply it to the new world of investment in private companies. Using our Virtual Private Funds an investor is able to diversify their investment across several companies that have all gone through a diligence process.
The VPF enables the fund operator to discover opportunities and negotiate fair terms with a company on behalf of the investors and provide all the capital a company needs without the risks of a lengthly public funding campaign (for example only 36% of Kickstarter projects are successful).
As investors seek out new opportunities among the spectrum of private and public company investments they will find that the rights of shareholder control fluctuate wildly. Shareholder control in the public markets has been abused by both companies and activists, resulting in elaborate strategies on both sides to maintain or usurp control of a company.
Investing in private companies offers inherently less control and while we don’t yet have standards for shareholder input in the private markets we believe that, as Jeff Gramm says:
“On the whole we are better off with engaged, active investors rather than complacent, checked-out ones.”
Thanks for reading and if you have opinions on shareholder control (in public or private companies) we’d love to hear from you. You can follow/message us on Medium, or on Twitter, or join our mailing list. -Chroma
