The Hidden Danger of IPOs Like Groupon and LinkedIn -- and What It Will Cost
The highly successful IPO of online firm LinkedIn (LNKD) and a similar pending offering from Groupon have raised concerns about another tech bubble, given their shaky business models. But the more important concern they should raise has to do with their shaky governance models.
Both companies offer a dangerous dual-class share structure. The public stockholder shares have limited voting rights while the insiders get shares with super voting rights, so they have exclusive rights to choose the board and approve major structural decisions. This gives insiders the best of both worlds -- the access to capital and limited liability of a public company on one hand, and the control offered by a private company. Great for them; lousy for shareholders.
One share, one vote -- except where noted
NYSE rules supporting single classes of stock go back before the 1929 stock market crash. Then-chairman John Phelan called one share/one vote "good for listed companies, good for the shareholders, and good for this country." The most sophisticated investors agree. A 2008 study showed that controlling for other variables, institutional ownership is significantly lower in dual class companies. Only 39 of the S&P 500 have multiple classes of stock, fewer if you eliminate those, like Berkshire Hathaway, that make both classes available to anyone who wants to buy them instead of limiting them to insiders.
In general, companies go public with a one vote per share structure except for those that are family controlled (like Ford and Molson Coors). Influential and prestigious U.S. newspapers like the Washington Post, New York Times, and Wall Street Journal have also traditionally had dual class stock. Of course, they were family controlled as well, but in their cases the dual-class structure also offered insulation from short-term commercial considerations and pressure that could interfere with the workings of an energetic free press.
LinkedIn's new investors will get one vote per share. The insiders get ten votes per share. BNET's own Jim Edwards points out that Groupon investors do not even know how diminished their voting rights will be:
Read page 89 of the prospectus. The company has left blank exactly how many votes Class B shares (for management) will be worth compared to each Class A share (for the plebs). But at least they've been honest about the fact that owning a share in GRPN won't give you any influence over the company or its board of directors.Why voting rights matter
The 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.
It is not a coincidence that there were massive failures of oversight at insider-controlled dual class public companies like Adelphia and Hollinger. Google's dual class structure is fine as long as Larry Page and Sergey Brin focus on creating long-term value for shareholders. But Google will become a mature, established, and inevitably less nimble firm. Page and Brin or their heirs may decide that making money is not as important to them as it once was. Just when the voting rights will be most needed, they won't be there.
Limited voting shares are like an umbrella that protects you except when it rains. Eventually, the lack-of-control discount will blow a hole in the share price.
Walmart (WMT) shareholders like Change to Win have raised concerns about excessive compensation, poor performance, conflicts of interest, softening performance metrics and money spent on buying back stock instead of investing in the business.
At least part of the incentive for this use of corporate cash is that it will tip insider control over 50 percent, all done using other people's money. The public shareholders will have no recourse except to sell at a loss. There may be a short-term play in arbitraging limited voting shares. But as an investment, you'd do better with a Groupon for a half-priced haircut.
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