Snap Inc. (SNAP), the parent company of the ephemeral photo app Snapchat, is finally allowing the public to own a piece of its business. However, these new investors will have no voting rights and thus effectively have no say in how Snap runs its business.
Anne Simpson, an Investment Director and corporate governance expert at the pension fund giant CalPERS, recently told Yahoo Finance that such a voting rights scheme amounts to “banana republic governance” for Snap.
“It’s very odd for a forward-looking sector like tech to have a very backward looking view of their finances,” Simpson said. “This really flies in the face of what markets are all about. You’ll have a Soviet style economy nestled within the most innovative sector in the world.”
Other Silicon Valley behemoths, notably Facebook (FB) and Alphabet (GOOG), have gone public using dual-class shares in the past. These dual class shares entitle founders and early investors to super-voting rights, which allow them to exert control over the companies they built — even after the companies are publicly traded. Snap, however, will be the first company to go public with stock that has zero voting rights.
Single-class shares historically outperform
The notion of dual class shares, such as the stock issued by Facebook and Google, is a highly controversial topic on Wall Street in itself. A raft of academic and industry studies have shown that dual-class shares with super-voting rights underperform, on average, the traditional single-class “one share one vote” structure.
“This [single class voting stock] isn’t just good economic theory: There is research behind this,” Simpson said.
For example, a 2012 study from the Council of Institutional Investors (CII), a nonprofit association of asset managers with more than $20 trillion in assets under management, suggests that “controlled companies” underperform companies with a more traditional, broadly held “one share one vote” share structure. The study looked at total shareholder return over a ten-year period. (Note: CalPERS is a member of the Council of Institutional Investors.)
The CII report finds “The average 10 year total shareholder return for control companies with multiclass structures was 7.52 percent, compared to 9.76 percent for non-controlled companies and 14.26 percent for control companies with a single share class.”
In other words, companies where outside shareholders can exert pressure on management via voting rights significantly outperform companies where insiders are able to exert more powerful control. A sequel study, published by CII in 2016, reaches similar conclusions.
The counter-argument, which supports the notion of dual class shares and super voting rights, is often framed this way: Dual class shares allow investors, especially founders, to manage their company more strategically — with an emphasis on long-term value creation. This line of argument holds that dual class shares insulate management from the pressures of short-term performance metrics, such as quarterly earnings. (A historical example is the case of Steve Jobs: If Jobs had been granted substantial super-voting rights during Apple’s IPO it’s far less likely that he would have lost control of Apple — which led to his firing in 1985 from the iconic company he co-founded.)
The arguments for and against dual-class stock schemes have both supporters and detractors — but Snap’s IPO certainly represents a major shift in the arms race for corporate control.
If retail investors receive no voting stock during an IPO they are, of course, denied the opportunity to participate in proxy votes. Similarly, institutional investors — with their experience providing a quasi-oversight function in operations & corporate governance — would be deprived of say in the way companies operate. Snap’s equity structure won’t even allow institutional investors to register a “protest vote”.
Proxy votes where management’s view ultimately prevails, despite the vote of minority shareholders, raise the profile of important issues and inform shareholders about key management issues in a framework contrary to management’s views. The voting process itself, where institutional shareholders can be heard, can be an inherently valuable one.
Despite skepticism about Snap’s future economic viability — the company lost over half a billion dollars in 2016 — Snap has captured significant attention share in the youth demographic. Evan Spiegel and Bobby Murphy, the two founders of Snap who will own 100% of the highest voting power shares, have created a company with over 161 million Daily Active Users, who check the Snapchat app an average of 18 times a day. Spiegel and Murphy’s accomplishment in building their brand and ecosystem isn’t one that should be easily dismissed.
While the future success of Snap is by no means a certainty, it’s not a contingency that should be ignored. If Snap is a runaway success, it’s not unreasonable to expect that more IPOs will follow Snap’s lead — and issue shares without voting rights.
Those follow-on effects at future IPOs may be the greatest risk of all.