Technology companies are big business. But they also tend to be dominated by the founder, or group of founders, who continue to control how their companies are run even after listing – through dual-class share structures.
Mark Zuckerberg, for instance, wields absolute power at Facebook despite holding less than 1% of its publicly traded stock, while Jeff Bezos effectively controls US online retailer Amazon (he holds about 16.17% of outstanding shares).
While most such companies are listed in the US – with some exceptions, such as Tokyo-listed Softbank – dual-class shares are gaining traction in Asia, too.
In January the Singapore Exchange (SGX) declared it would allow dual-class share structures. The Hong Kong Exchange (HKEx) followed suit in April, in a transparent attempt to convince fast-growing Chinese tech companies to choose it over New York.
As concepts of environmental, social and governance (ESG) principles gain traction globally, that’s causing some issues. Governance is a vital component for investors to best assess such risks, but it does not lie easy with autocratic levels of control.
Yet stocks such as Facebook have paid off for investors who have stuck with them. While the company's share price plunged from $209.94 to $174.89 upon its earnings announcement in late July, they have done very well on a multi-year view; the price stood at $115.05 at the end of 2016.
That leaves ESG-savvy investors with a problem: how to best apply their principles while not missing out on such big performers? Mary Leung, head of advocacy for Asia at the CFA Institute, noted that no fund managers appear to have avoided buying tech company shares because of dual-class share structures.
“Investors are pragmatic; they go where there is value,” she said.
There are some guidelines ESG-conscious investors can consider when viewing fast-growing tech companies employing dual-class shares. To begin with, Louise Dudley, a global equities portfolio manager at Hermes Asset Management, said investors should focus on how much information the company shares with investors.
Another key step is to assess just how fundamental the company founder has been to its success. “If a founder company has been growing for 10 or 20 years and its driving force is a visionary strategist who has transformed their business, then … we think it’s right that they get rewarded,” she noted.
Ultimately investors have to weigh how much they trust the leaders of companies that have deliberately skewed voting control against them.
Are they honest and open? Do they take criticism well? Can they articulate their goals and offer sensible responses to setbacks? Good governance matters because it reduces the potential for bad behaviour or bad news to surprise.
Would-be common shareholders should also consider where the company operates. “If it operates in emerging countries where there is a lot of corruption and higher risks and they are exposed to fines, they may not be able to survive as well over time,” noted Peers.
It also behoves fast-growing companies to have some level of internal check on their leader, no matter how brilliant they are. Separating chairman and CEO positions is a sensible step, as is ensuring that the company has an independent board and strong governance structure.
“Where there is a strong founder we look to ensure we have good access to other board members to reinforce our view that … there are adequate checks and measures,” said Hermes’s Dudley.
Some market associations, including the CFA Institute, also advocate that founder-owners reduce their absolute control over time.
Some have done so; Amazon’s Bezos for example is choosing to slowly decrease his share ownership. But a more rules-based option would be for shares with disproportionate voting rights to have a set lifespan, such as seven years.
The idea is that the founders maintain their control and strategic vision immediately after listing, but as time goes by they step back and give regular investors more say. According to Leung this makes sense, because the value the founder offers diminishes over time.
“What the academic analysis tells us is that even though a founding shareholder may work magic, three to five years after the IPO the company’s performance decays,” she said. “It comes to a point that it is no longer efficient [to maintain the control of the founder].”
SGX didn’t respond to questions over sunset clauses; HKEx noted that its weighted vote shares have a “natural sunset” when weighted vote share holders die, get incapacitated or leave their position as a director.
Many of the world’s best-known tech companies have rewarded their public investors handsomely for their truncated rights since listing. But as more tech company founders seek to use share structures to retain post-listing control – with the support of exchanges – investors need to consider whether they truly merit it, and if such power should subside over time.
Not every company is a run by a benevolent dictator, after all.
This is the second in a two-part series on owner-dominated technology companies and is part of a feature in AsianInvestor’s August/September magazine. For the first part of this story, click here.