Paul Hodgson: Insider and controlled shares are keeping out public shareholders

When you Google search “controlled companies” the only answers that come up are US companies. A controlled company is one where the majority of the voting shares are controlled by a single individual or group of individuals or companies. Shareholders elsewhere in the Western economies would never buy into such a company, though many own shares in US controlled companies. Why? Because these companies are an accepted and legal part of that economy and if you invest in indexed funds you have to buy the stock because they are in the index. But it’s not just controlled companies that offer serious barriers to shareholder democracy. Sometimes a single shareholder, usually an insider such as a founder or CEO, owning a huge swath of shares is enough to block shareholder demands. We’re talking Facebook, Google, Comcast and Yahoo! in the controlled company bracket, and Walmart, T-Mobile, Ralph Lauren, and Urban Outfitters in the insider influence bracket, to name just a few.
Objections to controlled companies are founded on the lack of influence that public shareholders can have on any issue within that company. Anything, and I mean anything, that comes up for a shareholder vote is only going to get approved if the controlling stockholders approve it; one reason why approval for Say-on-Pay votes is so high at controlled companies. Who would vote against their own pay package? If the controlling stockholder or stockholders disapprove, it doesn’t matter if 100 per cent of public shareholders want it to happen, it won’t. Similarly with companies where insiders own large minority shareholdings, even where a majority of public shareholders vote to approve a particular corporate action, it typically does not pass.
So what? you might ask. If the controlling shareholders own the companies, surely they have a right to decide what happens in them. But this is where the argument falls down. The controlling shareholders don’t own the companies, they own the votes. In other words, their influence far outweighs their economic exposure because the shares they own are usually supervoting shares, worth as much as 10 votes per share. It seems extraordinary that one of the major democracies in the world should allow such inequitable and undemocratic company structures, yet, as can be seen from the above selection, these are not all old, established, founder companies from the bad old times of corporate governance. Some of them are just a few years old.
For example, Alastair Campbell, the former Director of Communications and Strategy for Tony Blair, the ex UK Prime Minister, in his latest book Winners: And How They Succeed, quotes the letter written to shareholders by Google founders Larry Page and Sergey Brin at the time of the company’s public offering: “We have implemented a corporate structure that is designed to protect Google’s ability to innovate and retain its most distinctive characteristics.” While Campbell quotes the letter to give an example of a clear leadership structure “able to make big decisions quickly”, he fails to question whether such a corporate structure is actually necessary to be able to make such decisions. In fact, all the other corporate examples of winning in his book prove that it is not – Virgin, TalkTalk, Metro Bank, General Electric, none of these have controlling shareholders, despite having, in most cases, very strong and charismatic founders.So what does this control mean in practice? At Facebook, for example, the controlled shares owned largely by founder Mark Zuckerberg outgun the publicly held shares by about 3.5:1. The vast majority of the controlled shares are “B” shares that have 10 votes per share. So, in 2014, when shareholder resolutions were on the ballot at Facebook to support: a change to shareholder voting; a corporate lobbying disclosure report; and a sustainability report, all of these were easily defeated, with 80-90 per cent of “votes” cast against them. Labour union AFSCME’s John Keenan tracks the issue closely and regularly analyses what would have happened to shareholder resolutions and other proxy voting items if controlling and insider shares were excluded. I asked him for his findings on a group of around 10 companies that met these criteria in both 2014 and 2015. He calculated, for example, that if only outside votes were counted at Facebook in 2014, the shareholder vote resolution (which calls for one vote per share) and the lobbying disclosure report resolution would both have passed. And the sustainability report resolution would have received over a third of outstanding outsider votes. The shareholder vote was up again this year, and received the support of almost all the public shareholders. But, of course, by its very nature, an equal share equal vote resolution can never pass in such an unequal structure. How could it succeed? It is likely to be implemented only if Zuckerberg’s board voluntarily changed the corporate structure. But this is extraordinarily unlikely.
This story is repeated over and over at other US controlled companies. Take Google: in 2014, for example, an equal voting resolution failed at the “polls” despite receiving the support of 81% of public shareholders. And a resolution calling for an independent chairman, that would have dislodged former CEO Eric Schmidt from the job, almost received majority support from public shareholders but barely made a showing in the final vote tally. Similarly in 2015, the vast majority of Google’s public shareholders again supported resolutions for one share one vote and a simple majority voting standard. In addition, a fifth of them even opposed Google’s new stock incentive plan, and almost half objected to the re-election of director John Doerr, a partner at Kleiner Perkins Caufield & Byers, one of the venture capitalists that initially backed Google, as well as Zynga, Intuit, Twitter…. But he was re-elected, the stock plan approved and neither of the two shareholder resolutions were even considered.
Of the “insider influence” companies, at Amazon, a 2015 proxy access resolution would have received majority support had founder and CEO Jeffrey Bezos not voted his very substantial holding against it. At Kellogg Company, in 2014, a simple majority vote resolution… got majority support, but only among outside shareholders.
At T-Mobile, significant minority protest votes against 6 directors including CEO John Legere were noted among outside shareholders in 2014, with the number of protest votes increasing in 2015, and over a larger number of directors – nine. Even more significant, had Deutsche Telekom’s massive stockholding not been voted against it, a proxy access resolution would have passed with two-thirds of outside shareholder support.

At Urban Outfitters, a human rights risk assessment resolution in 2014 received the support of a third of outside voters compared to only a quarter of total outstanding shares, and in 2015, a clear majority of outside shareholders supported a proxy access resolution and voted against two directors associated with private equity firms. The founder and his wife, the “chief creative officer”, also received substantial minority protest votes, but because of their voting power were comfortably re-elected.
At Walmart, in 2014, resolutions on lobbying disclosure, the implementation of a pay clawback policy and for an independent chair received between a third and two-fifths of support from public shareholders. To be fair to Walmart, the lobbying disclosures were substantially implemented in 2015, though they fell short of what shareholder Zevin Asset Management actually requested. Such a response, however, is a rarity, and neither of the other resolutions were acted on.Some shareholders have no interest in bolstering up this undemocratic behaviour by supporting it with investment, and do not buy stock in controlled or insider dominated companies, but more have no choice and yet more invest so that they can at least try to change corporate structures and behaviours from inside. While a complete change in the attitude of companies and insiders to majority outside shareholder influence might allow for a more equitable treatment of such shareholders, this voluntary change is unlikely. Nor does it seem as if the SEC is likely to cease allowing controlled companies, either existing or new public offerings. Nevertheless, this last is what should happen. One shareholder one vote should be the rule for the largest democracy in the world.

Paul Hodgson is an independent governance analyst.