Why Dual Class Stock? A Response to CII's Petition to Nasdaq For Mandatory Sunset Provisions

Abstract

On March 28, 2019 the Nasdaq Listing Council invited me to respond to the recent proposal by the Council of Institutional Investors (CII) requesting Nasdaq (and the NYSE) to adopt rules requiring a company going public with dual class shares to include a mandatory provision in the company's charter. Under the CII proposal, the company would generally have to convert the dual class shares into a single class after seven (7) years unless an extension was approved by stockholders voting separately as a class. This article briefly outlines my reasons for opposing CII's proposal and offers some alternative ideas for moving forward. My response focused upon three issues. First, I analyzed some of the governance and market forces that have led many of the most innovative and successful companies in the country (and indeed across the globe) to adopt dual class stock. This section focused upon what is the core issue of corporate governance but often goes unspoken: who gets to elect directors? This is the critical governance issue because directors manage the corporation and are responsive to those who elect them. Our corporate republic is not a direct democracy; stockholders do not run the corporation. Rather, corporations are managed and run by the board of directors. Yet over the last few decades, changes in the financial markets and the increased separation of from ownership has led to a situation where directors are increasingly elected by a small group of institutional investors and activist fund managers, including activist hedge funds. Confronted with a reality where directors are elected by this small group of investors, it should come as no surprise that some of our most innovative and entrepreneurial leaders, as well as those who support them, seek a better way to elect directors. Second, I identify some of the many problems with CII's analysis. As part of this, I demonstrate that many of the studies identified by CII do not support the claim for a seven (7) year sunset period, and in fact show that companies with dual class stock outperform their single class peers for considerably longer periods of time. Additionally, the most recent study by two highly respected scholars who have carefully reviewed all the literature and studies identified by CII concludes that compulsory sunsets, and time-based sunsets in particular, are an inappropriate response to the potential problems of dual class stock. In this section I further discuss recent studies that support a reality that I (and I suspect many practitioners) have long recognized: that there is little correlation between so-called best governance practices and either corporate performance or corporate governance. Rather, the studies on corporate governance typically measure adherence to the particular structural governance measures that are favored by certain institutional investors and/or academics, but that these studies do not measure whether in fact a company is well-governed, much less whether there is any correlation between a well-governed company and its performance. For this reason as well I discuss why it is important to continue to allow the system of private ordering on these types of governance issues to exist. The third section of my paper offered some specific compromise proposals to CII and other institutional investors, with the hope of better achieving the joint goals of fostering better governance while also opening up the process for director selection. In addition to discussing these proposals, I also call on the Nasdaq (and the NYSE) to continue to play their historic role as facilitators to this debate, and in my talk I suggested that Nasdaq consider convening a group of experts to consider the various issues and make recommendations to the exchanges.