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Summary:

Google has issued new non-voting shares that help consolidate power in the hands of its co-founders, in the same way Mark Zuckerberg controls Facebook. But just because you happen to like the dictator doesn’t mean you aren’t living in a dictatorship

In what many seem to see as a legal and financial footnote, Google issued a new class of shares on Thursday that will trade under a separate ticker symbol because they carry no right to vote, unlike the regular class of Google stock. Why would the company do this? Because it wants to be able to issue new shares either as compensation or to use in acquisitions, without changing the existing ownership structure of the company — one which gives Larry Page and Sergey Brin control of the votes through the multiple-voting shares they hold.

In fact, for all intents and purposes, the existing single-vote shares in Google might as well have no voting rights, because Page and Brin control enough of the multiple-voting variety (84 percent) to make them useless. In a similar way, Mark Zuckerberg exercises unilateral control over Facebook by virtue of his holdings in multiple-voting shares — voting control that will even extend beyond the grave — and he also controls a majority of the board of directors by way of voting proxies.

Here’s how it works in practice: shareholders didn’t like Google’s plan to issue the new class of non-voting stock, so they marshalled 180 million votes at the last general meeting, a larger number than almost any other measure that reached the floor. The proposal died, however, after 551 million votes against — 467 million of which came from Larry and Sergey, despite the fact that they only own about 16 percent of the outstanding shares of the company.

Shareholder rights vs. founder vision

This is not a new thing, of course. Google laid out the details of its share structure in its offering prospectus in 2004, and was clear about why it wanted to organize the company in that way: because Page and Brin believed they were embarked on a multi-decade journey to create a new kind of company, and didn’t want to be bogged down by the short-term interests of investors. As they put it at the time:

“As a private company, we have concentrated on the long term, and this has served us well. As a public company, we will do the same. In our opinion, outside pressures too often tempt companies to sacrifice long term opportunities to meet quarterly market expectations.”

This is an appealing idea: the founders as stewards of a particular vision, who must be free from the constraints of the hoi polloi, etc. so that they can pursue things like self-driving cars and Google Glass, for the betterment of humanity of course. By this reasoning, shareholders and investors are just along for the ride — if they don’t like the vision, then they are free to sell their shares and look elsewhere, because that is the only choice they are given.

Cementing power in the hands of the few

Despite this grand-vision theory, however, multiple-voting share structures have historically been used to centralize control in the hands of a few, in order to make it harder for investors to mount a revolt — and also in many cases as a way of funnelling a majority of the surplus income (via dividends and other mechanisms) into the hands of a controlling shareholder and/or his or her family. This has been the case with many large media companies, including the New York Times and the pre-Bezos Washington Post, as David Carr detailed in a recent story.

For media entities — which in some ways were the search engines and social networks of their day — part of the rationale for the multiple-voting structure was to protect the mission of the company: the pursuit of journalistic truth was (theoretically at least) so important that one couldn’t risk having it fall into the hands of rapacious bankers or foreign competitors.

Google clearly sees its mission in a similar way, and Mark Zuckerberg arguably feels the same about Facebook’s purpose: namely, giving the world a platform through which to share everything they think and do. And that’s great. But both are also profit-oriented companies, not charitable enterprises — they both make decisions that benefit primarily their most important customers (advertisers) rather than their users. What ability do users have to influence those decisions? Zero. As Nick Summers at Bloomberg Businessweek put it:

“Here’s a philosophical question Google investors can ponder this morning: If you own stock in the tech giant, would you rather have voting rights that are essentially worthless or ones that are literally worthless?”

A benevolent dictator is still a dictator

Google Glass

The number one defense given for multiple-voting shares is the same one provided by Google in its original letter to shareholders: that short-term goals can distort a company’s vision and cause it to fail. But the flawed vision of a founder can do this just as easily, when there is no easy route to correcting that vision. Look at how long it took Yahoo to find its way — how much longer would it have taken if Jerry Yang and David Filo had multiple-voting stock? And when a founder sets out to plunder a company the way former Lord Conrad Black did with Hollinger Inc., there is little recourse for shareholders.

It’s true that controlling the majority of board votes and shareholder votes allows Mark Zuckerberg to make audacious bets, like the one he made by dropping a mind-boggling $19 billion on the acquisition of WhatsApp or by buying Instagram for a less mind-boggling $1 billion — a deal he cut before he even notified the board of his interest in the company. And in Silicon Valley, where the cult of the visionary founder reigns supreme, this model no doubt seems totally appropriate, to the point where Zynga, LinkedIn and others have adopted it.

But the principle behind issuing shares to the public is that a bargain is struck, in which the company agrees to do certain things in return for that money, and shareholders have the right to hold them to that commitment through shareholder meetings, votes and so on. That bargain becomes completely one-sided when the owners maintain what amounts to unassailable voting control.

The bottom line is that multiple-voting shares work well for everyone when a company is doing well, and making good decisions. Shareholders of Google have probably been more than happy to go along for the ride with Larry and Sergey (although research shows that companies with multiple share structures tend to underperform). But this is a little like approving of dictatorship because your dictator happens to be a great guy. That doesn’t mean the model isn’t flawed — it just means those flaws haven’t become obvious yet.

Post and photo thumbnails courtesy of Thinkstock / Sergey Nivens and Flickr user Thomas Hawk

  1. A Large Fund that just bought 20% of the voting shares Thursday, April 3, 2014

    What and voting shares are a democracy? April Fools day was a couple days ago.

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  2. How can you completely skip over the fact that nobody is forced to buy Google or Facebook shares, and anyone who wants to can find out the voting rights that come with those shares before they’re purchased?
    This ownership structure is part of the deal the companies are offering by selling shares; it’s not illegal by any means; buyers should consider the facts and can decide not to purchase if they don’t like that structure.
    Where’s the fire again?

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    1. JenniferDawn Friday, April 4, 2014

      no kidding….don’t like it? DON’T INVEST.

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  3. William Mougayar Thursday, April 3, 2014

    You make a good argument Mathew, but as long as these companies do well, and their “dictators” seem to be competent, smart and bold, then it’s a moot subject. What do shareholders know about a company’s business? Nothing. They are just investors, and should be happy about the returns they got, which in both cases, have been spectacular.

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    1. Thanks, William — that’s a popular response. So then why do we expect companies to offer voting shares at all, or to have shareholder rights agreements, or to respond to investors in any way? It’s fine to say that they have done well so far — so did Hollinger or Magna. What happens when that changes?

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      1. More to the point, Matthew, what’s the motivation of the typical investor? Profit, correct? So why the assumption that s/he has the long-term interest of the company at heart? Isn’t that rarely the case?

        Personally, I have never understood why stockholders expect a voice in running a company. Stock is usually bought on the expectation of participating in increased profit. I think that, if we think of a company as a bus, the riders need to be quiet and let the driver do the driving. After all, nobody is dragged onboard.

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  4. Ormy Underhill Thursday, April 3, 2014

    It keeps the barbarians outside of the gates. Carl Icahn just one example.

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  5. Really interesting issue this. As well as under performance, academic research suggests that companies with dual class structures tend to engage in empire building through acquisition and capex… Oculus anyone? More details here: t https://medium.com/p/d6ade5a19ea2

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  6. Richard Windsor Thursday, April 3, 2014

    Hi Matthew, You are right on the money and this is one of my bugbears. However the comments hear are correct. No one is forced to buy the shares. Hence the way to look at it (and the way I do it) is to value the company and then take 30% off for this governance shortcoming. With a 30% discount I think that the investor is being adequately compensated for the short coming in corporate governance. The other issue is that while the shares keep going up no one will care but when things go wrong this issue will become front and centre. Remember the parable of Ericsson in 2002. (emergency rights issue to stave off bankruptcy triggered by this very issue in my opinion.). Cheers Richard. Radio Free Mobile.

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    1. Ian Betteridge Monday, April 7, 2014

      I would only take value off the company if I believed that stockholders knew more about running it than the directors. That is very, very rarely the case.

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  7. In practice very few shareholders have any relevant power, so it’s between the founders holding the power and a bunch of funds holding the power. In a society where the vast majority of wealth is the hands of a few, the system isn’t working as intended anyway. You kinda take the reality out of it and assume the our society is functional but it’s not.

    In the end having someone that cares about the company hold power tends to be beneficial in many ways. Big shareholders sometimes have different interests , public companies tend to be less innovative – it means taking risks – and think about the short term.

    You are also very very wrong to call the system a democracy, in a democracy individuals are equal. The system you are asking for is an oligarchy .
    Is oligarchy better than better than dictatorship? In politics ,at best, not by much but here it is a bit different. The dictator’s primary objective here is not to keep the power, that’s not even a concern and is usually well intentioned. The oligarchs are do care about more immediate objectives since that’s what allows them to keep, or increase power (power is money in general here,not the stake in a company).

    Ofc what Google does might seem unfair but they set the rule from the start, we can take or leave it.

    Anyway i urge you to rethink this and rewrite it , you just can’t call it a democracy and if you care about a fix ,ask for a society were income/wealth inequality is not at ridiculous levels. Hell, you can even explore an option where shareholders have equal votes and the numbers of shares has no relevance, that would be democracy.

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      1. Guess i should have said a bit more at least.
        So i don’t agree that it is wrong as in unethical and in many cases it is better to have people that care about the company have the power. And ,since in our world very few hold the vast majority of capital, we do need fundamental changes for the system to be ok.
        But I also don’t think that they should be allowed to keep control without a majority, it just opens the door to abuses and any 50+1 % can take over and exclude the other investors for good, just like big money practically excludes everybody else now.

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  8. Canada had two tier stock ownership in many of its companies years ago. At the time I recall this was often criticized by some at home and particularly the US media and financial organizations as being undemocratic.

    Most companies over time bowed to the pressure of investors and eliminated this structure in favour of one class of shares and only a few instances of the old structure remain. Now that the American’s are embracing the structure it is an OK thing to do. Laughable.

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  9. If you don’t like living in these dictatorships, just leave–sell your shares. Or don’t move in in the first place. Every investor knows the terms of their investment. There are a few thousand other stocks you can park you money in if being able to vote on proxy statements, or on who is on the board is important to you.

    In fact, some investors may like the idea that these companies’ managements won’t have to deal with distractions like hostile takeovers and activist shareholders. They may consider these attributes attractive attributes of these companies. Attributes that increase shareholder value.

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  10. Michau Kowalski Friday, April 4, 2014

    see #3. in book: The.Most.Important.Knowledge.You.would.Ever.Read.Implement.and.Live.up.to.Forever

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