Silicon Valley Boardrooms: Distinctive Dynamics in Corporate Governance

•  Joseph Grundfest, William A Franke Professor of Law and Business, Stanford Law School & Co-Director, Rock Center on Corporate Governance, Stanford University, USA
• Mark Lonergan, Founder and Managing Partner, Lonergan Partners, USA
• Aeisha Mastagni, Investment Officer, California State Teachers' Retirement System, USA 
• Suzan Miller, Corporate Secretary, Corporate Vice President & Deputy General Counsel, Intel Corporation, USA
• Larry Sonsini, Chairman, Wilson Sonsini Goodrich & Rosati, USA  
• Chaired by: Abe Friedman, Founder & Managing Partner, Camberview, USA

Abe Friedman, Founder & Managing Partner, Camberview, USA:

We have a really phenomenal panel today to talk about some of the distinctive governance features that we all know exist in Silicon Valley boardrooms.  And I’d like to just take a minute to introduce my fellow panellists so you have a little bit of context for how lucky we are to have this group assembled today. 

The first question I have for the panel is that Management Teams in Silicon Valley often have a delayed focus on profitability and they’re trying to build foundations for their businesses.  Instead of focusing on short-term earnings they tend to be thinking about how they can build products and services that may take many years to come to profitability, but are hopefully going to be particularly valuable for their owners over time. As a result CEOs and boards in Silicon Valley often assert that they need to be insulated from short-termism and that they need some sort of special governance protections to enable them to have the long-term thinking that’s required to innovate. Silicon Valley is really an engine of innovation in the US. So if you all could just take a moment to comment on this point and how important this is or is not to protecting innovation in Silicon Valley. 

Larry Sonsini, Chairman, Wilson Sonsini Goodrich & Rosati, USA:

The commercialisation of technology really is a long journey there is no doubt about it.  What changes rapidly are cycles of technology, but what really takes time is building scale from a very early stage. Many people perceive that a company that is a technology company going public has reached that scale and that really is not the case.  Historically, going public was nothing more than a tool to fuel a scale and many companies that went public, or tried to go public, have a long way to go in building brand, building markets, penetrating. At the same time, most of the time, technology is disrupting other industries, so there’s an urgency to the business plan, but there’s a longevity to get there. 

So, clearly, the dialogue between short-termism or long-termism is a major issue in a technology company and there’s enormous pressure to build structures and cultures that really go for the long-term. That is just a reality that we have to deal with and what’s happening in governance is somewhat at odds with that kind of DNA and the challenge is where’s the balance going to be found.

Joseph Grundfest, William A Franke Professor of Law and Business, Stanford Law School and Co-Director Rock Centre, USA:

Let’s put this question in a much bigger perspective, the reality is that the number of public traded corporations in the United States is down by approximately half from the peak that was observed in approximately 1996.  Many different reasons, people will point to regulation, people will point to capital market factors or what have you, but the reality is that in the United States the attractiveness of being a standalone publically traded corporation has declined very significantly.

At the same time, if you look at Silicon Valley companies, the general ethos in the Valley is you want to stay private for as long as you possibly can. One of the reasons why companies want to stay private can is that the people in charge of building these companies aren’t looking forward to doing business with public equity investors.  

They look at their ability to grow companies while they’re private and controlled by venture capitalists and they look at the additional issues that result after an IPO and their calculation very simply is we’re going to stay private as long as we can. For an increasing number of companies they’ll say we would rather be bought by Intel, or we’d rather be bought by Facebook, we’d rather be bought by Google, than do an IPO on our own.  Founders in companies have a choice, people vote with their feet and what you’re seeing, not only in Silicon Valley, but throughout the United States, is an increasing number of entrepreneurs saying, it’s not worth it being public, given all of the fixed costs and all of the governance hassles and everything else associated with that.

Now, in terms of a variety of different approaches that companies are taking when they go public, I think it behoves anybody interested in this topic to have a look at the proxy statement out of Facebook and to study the changes that Facebook is thinking of making in connection with the issuance of their Class C shares and the changes that will also result to the Class B shares that are outstanding where Mark Zuckerberg currently has ten votes to one.  In effect, what’s going to happen is that by issuing these additional Class C non-voting shares Zuckerberg is going to give up the dynastic element of the ten to one control.  What it’s going to mean is he can’t pass control onto his heirs and his B high voting shares will lose their super voting privilege when he is no longer CEO of the corporation. 

So, in other words, this is the first situation where we are seeing a meaningful sunset provision being adopted by a CEO of a publically traded corporation. He is arguably one of the most successful CEOs that we have in the United States today and what he’s basically saying is not interested in building an empire.  That’s an important innovation and will be interesting to see if as companies go public in the future, they’ll have the standard A-B ten to one ratio or they’ll have an ABC structure, where you’ll have A shares, single voting shares, B shares that might have a sunset provision in them and C shares that’ll be non-voting shares and you can imagine the non-voting shares being used for acquisitions in the future and for other purposes.

In addition, those of you that have studied the Alibaba prospectus know that there’s de facto super voting control of Alibaba, not by any one individual, but within a committee of 35 senior employees within Alibaba.  I call this the Hong Kong model, alright.  You, in effect, have a Politbureau of 35 employees and they decide on the majority of the Board of Directors. You then have everybody with the one share, one vote, but you really only get to vote for candidates that are approved by the Alibaba Politbureau.  So, that’s an employee driven model.  Again, you don’t have the situation where an individual can have a dynasty, but you do have a situation where as a practical matter control of the publically traded corporation can’t be taken by any coalition of anyone in this room. I wouldn’t be surprised to see if we see additional innovations of this sort coming in the future.

Aeisha Mastagni, Investment Officer, CalSTRS, USA:

I won’t debate Joe’s facts about less companies going public, but I would debate the fact that they still want to do business with investors, the people in the room, because for investors like CalSTRS, we have a big private equity portfolio.

So, if a company’s not ready to go public, if it’s not ready to go public and have public type governance then we’re happy to have them stay private and tap those profitable companies that way.

 Abe Friedman:

If the company is in a position where it makes sense for them to go public because they need the capital that the public markets avail to fuel their growth, are there any circumstances in which there’s some transition period or some structures that are non-traditional, especially in an an innovative company and in the technology sector where CalSTRS thinks, that an alternate governance structure might be appropriate? 

Aeisha Mastagni:

What Joe was saying about the Facebook case, I think it is one step in the right direction.  The problem is when you have these structures that basically follow people beyond the grave. If you get the governance structure right at the beginning, everything else follows.  Because everything’s fine until it’s not fine. Getting the governance right is about accountability and when things don’t go right, minority shareholders don’t have a way to hold the board or the management accountable for their actions. 

I would just also just point a couple other things about these multi-class type structures, because the idea is to insulate them from the short-term pressures, but in actuality there’s several studies out there that show these multi-class controlled companies don’t outperform, they actually underperform non-controlled peers. Jon Lukomnik wrote a really interesting blog and it talked about controlling multi-class companies and they are actually longer tenured, less diverse, they have more CEOs and CFOs on the board and they pay their CEOs more than non-controlled companies. So, I think that’s another impediment for minority shareholders. 

Mark Lonergan, Founder and Managing Partner, Lonergan Partners, USA:

In our area, in our Silicon Valley 150, which is the largest public companies in the Silicon Valley, it was going great at Zinga until it was going terrible at Zinga, it was going great at GoPro until it was going terrible at GoPro. That question of recourse on the part of the investors is a pretty interesting question to ponder.  I would add one more thing, and this has to do with Joe’s comment about not wanting to go public, I know many of you are travelling here from out of the country, in our country we have something called ISS. It rates companies according to their, essentially, their trustworthiness and ISS has been very confused in their public statements about dual-class voting structures. The implication is that as long as they’re making money I suppose they’re okay, the moment they’re not making money, issues like board governance, diversity, even investor recourse, because number one. 

Abe Friedman:

I wanted to try to bring the audience into the discussion. The first question for the audience is Silicon Valley companies with defensive governance structures, such as dual-class, have a competitive a) advantage; or b) disadvantage? 56% of our audience believes that dual-class or some defensive governance structure in Silicon Valley gives a company, a competitive advantage, while 44% believes it gives the company a competitive disadvantage.  I’d be interested in the thinking of the panel on this question.  Maybe Suzan, I’ll start with you.  Obviously in terms of more traditional governance structure, how does that feel relative to the Googles and Facebooks and others of the world?

Suzan Miller, Corporate Secretary, Corporate Vice President & Deputy General Counsel, Intel Corporation, USA:

Before I moved into this role I spent a number of years as a General Counsellor of Intel Capital, we have a very large portfolio of start-up companies and who have seen a difference from the goals of the start-up companies as far as their interests and earnestness of trying to get public more quickly. There’s more of a fear of what that means and it’s not just about the short-term versus long-term, it’s just the overwhelming weight of what it means to be public now is bigger than it was before. As a company that has been public for a number of years with a one class one vote system, it’s hard to go back and figure out what we would do if we had to do it all over again, but from where we sit today one of the things that we have to do is we end up needing to make sure that you’re always keeping a mind the short-term interests and long-term interests.  So in communicating with the owners, with our stockholders, we have to think about how we communicate what we’re doing in the short-term and what we’re doing in the long-term, which means you’re talking about total shareholder returns, revenue growth, return to equity, at the same time you’re trying to communicate the what you’re trying to do strategically over the long haul and the long-term.

An advantage you would have if you didn’t have to do that, and I’m not saying that we need this, but I can see technology businesses can be extremely complicated.  Our business between the manufacturing and the long timeframe of doing the development, the multi-year cycles, it makes it difficult to educate when you’re communicating about both what’s happening in the short-term and the long-term. They’re complicated topics, so you spend a lot of time not just communicating but trying to educate; balance that need to educate with the need to keep some things confidential, because part of your competitive advantage is the confidential nature of where your technology development is.  So, that aspect of how do you keep your owners and your investors up-to-date on where you are, but not providing so much that you’re actually hurting your business by giving too much to your competitors, is one of the things that you have to deal with.

Larry Sonsini:

When we put a dual-class structure in at Google, quite frankly it was before all of the activism momentum moving into technology.  It was before a lot of the issues that we’re dealing with ranging from proxy access to majority voting and all of those kinds of things.  It was put in for a specific purpose and that is our business model is really opaque, we’re going to take moon shots and we’re going to miss. So, the stock is going to be volatile and we’re going to do things that are very long-term that may not have any short-term logic. 

What’s happening today is a lot different.  I am faced almost every day with companies coming to me saying, “I want a dual-class structure.  I’m going to be subject to activism.  I don’t want to go through what Yahoo’s going through or what others have gone through.”  The dual-class structure is sometimes being put in really to avoid any disruption. But the problem is disruption may be a disadvantage and an advantage, depending on how you look at risk.  One of the troubles with a dual-class structure is it insulates a one kind of thinking of the business model.  We put the structure in to defend and entrench this management and therefore we’re going to pursue this strategy and you lose nimbleness.  Because we do a lot of mergers, just did the LinkedIn Microsoft one, LinkedIn as a dual-class and it will interesting how that plays out in that context.  

Also, a dual-class sometimes is a damper on strategic partnership relationships.  So, although I’m a fan of this structure in the right case, because of the short-termism in the market we’ll talk about, there are really hazards to it as you live with it and see a development plan evolve.  Is it an advantage or is it a disadvantage?  Depends on what the risk is you’re trying to deal with. That’s how I think you have to look at it.

Abe Friedman:

Joe, why is working in a way that’s allowing so many companies not to go public but take their time and become huge $50 billion companies and above and still not be public?

Joseph Grundfest:

What you can’t find in the publically traded markets easily these days is, if you look at the efficient frontier, high-risk, high-return securities.  If you look at the publically traded markets and you say, how many stocks are there where I might be able to get a 5X over the next two or three years, it’s a short list. If you’re looking for those returns that are on the efficient frontier you’re going to have to look to the private markets. In the private markets, as we’ve observed, governance structures are extraordinarily different and the fact that investors are hungry for yield and for a particular kind of risk, particularly in an environment where growth opportunities for established publically traded corporations are extraordinarily low, we’re going to see large amounts of capital become available at late stage companies in Silicon Valley.  That’s the reason why you can grow a company like Uber to $61 billion and grow companies like Lift and Airbnb. If they could solve their liquidity issues without going public, I think it would be a high probability that these companies would like to run themselves.

Larry Sonsini:

I hear that a lot, but in the companies that we represent, it’s the minority that say I don’t want to go public because of what can happen in the market in the short-term. The reality is it’s very hard to scale a company without public currency. You can’t find liquidity for your employees who really depend upon.  The secondary trading market for private companies is highly inefficient. You need currency to do acquisitions in a meaningful way.  You can’t leverage your balance sheet up in a technology company and do everything for cash.  You need currency for partnerships that is public. Staying private a long time ultimately becomes very costly. 

The average time to get public was probably around five to seven years.  That timeframe today has doubled and there’s a cost to it.  Now, we’ve been able to build great companies with that cost because so much capital has been available. There’s been a growth in private capital in this country that is outstanding.  We used to just deal with venture capital.  Today you have micro venture capital, you have traditional venture capital, you have private equity, growth equity, institutional equity; the layers of capital are phenomenal. That’s one of the reasons why companies don’t go public, is they can get capital easier and it’s just taking longer to scale these enterprises.  So, it’s got to be a balance factor.  But clearly, what is troubling is not the transition from private to public, it’s once you are public the turnover in your shareholder base.  On average a US company ownership turns over in a year and the pressures from activism, the governance quotient tests of ISS and others. Many of the institutions who are passively activists, really are causing this concern on short-termism that’s feeding itself and filtering back down to private companies. I think that’s the dilemma and debate we had to have. 

Suzan Miller:

I don’t want to mix long-term thinking up with short-term goals, because you have to have short-term goals and deliverables if you’re going to accomplish what you want to accomplish in the long-term. Now, you’re constantly pivoting and adjusting what you need to do, but holding companies accountable for what they’re trying to accomplish quarter by quarter or year by year, or whatever the right timeframe is, depending on what your long-term cycle is, that’s an important thing.  But I want to distinguish that from how we’re talking about short-termism.

Abe Friedman:

I think the example at Intel is Moore’s Law, where you have to reduce the size of a chip by half every two years, or something, to that effect?

Suzan Miller:

Yes, so it would be double the functionality on the chip every two years. Moore’s Law is interesting. People think of it as a technical thing. It’s actually an economic law. And the timeframe for doing the development around the process or technology doesn’t always stay with that timeframe, because it’s, frankly it’s just magic what they come up with. This constant pressure of what are you doing towards Moore’s Law and are you meeting that goal that’s set there, versus what are you trying to accomplish long-term?  And it’s a continual discussion and we’re lucky in that we have a very adept, you know, IRT that does a lot of outreach and spends a lot of time with our investors talking and educating on the process.  But even still, frankly it’s a struggle for people in the company to understand all the magic, it’s almost impossible if you’re outside.

Abe Friedman:

In the US we have recently seen a sweep of proxy access coming into place and I think a presumption on the part of all of us that proxy access is now finally here and it will be in place at most big companies in America over the next few years. Interestingly, proxy access is the first time that the investor community has really embraced differential rights for different shareholders. So, in other words shareholders who hold shares for longer periods of time have a special right that other shareholders don’t have. Can you tell us about the thinking in the investor community around that set of rights and what does it say about the evolution of thinking on this topic in the investor community around the need to really protect long-term value.

Aeisha Mastagni:

At CalSTRS we passionately believe in a one share, one vote principle and policy. Proxy access developed the way it did partly because of the constraints and the long-term nature of trying to get somebody onto a proxy.  I think that we also want to protect ourselves from ‘hit and run’ activists, because we think there’s lots of flavours out there and we’re the ultimate long-term shareholder.  You know, we’re going to own them as long as there’s Teachers in California. We want to protect our own interests and we want to make sure that the folks that get a say in the boardroom really do have a long-term focus.

Abe Friedman:

What do you think about whether voting rights should differentiate between types of holders and whether it’s time to think about how to protect long-term thinking in the capital markets?

Larry Sonsini:

Well, I think it’s very timely and very important and necessary.  We have on our stock exchanges rules that basically prohibit listing public companies on the exchanges if they have disparate voting, or if it’s other than one vote, one share.  The history on that in this country is very interesting. In the 80s the stock exchanges allowed differential voting, allowed dual-class voting.  It’s interesting that a private company that adopts dual-class voting and then goes public is permitted to list and trades Google, Facebook, LinkedIn, Box, but companies already public can’t get there. The rationale came from the SEC, which was hung up on this concept, adopted a rule that was later basically staid by a District Court of Appeals that this rule that the SEC was trying to impose on the exchanges, mandating one share, one vote, was overreaching.  But nevertheless, pressure was put on the exchanges by the SEC and the exchanges bowed to that by adopting these rules, all of which can be interpreted differently and all of which can be repealed.  And I think that that is a topic now being debated. 

But why does it make sense?  There are two things that so called tenured voting, or time based voting, could do.  And those of you in France know that you have a law now that you can opt out of.  The concept is that if you’ve held your stock for a period of time, such as four years, you have ten votes. It rewards long-term patient capital. Holding stock for long-term to get to the ten votes, is going to have to be a governance structure that makes sense that protects the long-term value creation model. I think when that gets more thought you’re going to see the opportunity for rather than dual-class, time based voting which treats everyone the same, just depending on how long you hold the shares.

Joseph Grundfest:

Presumably the only way that you would get from a traditional one share, one vote model to a time based model is if the current one share, one vote shareholders vote by a democratic majority to adopt the new model.  So, moving from the current model to the new model would be a democratic process and it would respect one share, one vote.  If you think about the implications, the vast majority of you sitting in this room are affiliated with organisations that tend to hold their stock for a long period of time. The statistic that Larry earlier cited about the average, you know, turnover in publically traded corporations being one year or less, that’s an interesting number.  It’s true, but at the same time that it’s entirely accurate, forgive me, it’s also totally misleading for the following reason. What you have is high velocity shares and low velocity shares.  Those of you in this room typically hold low velocity shares and you can wind up holding those low velocity shares forever. On the other hand, you have other traders who really are in the trading business and a single share, if you could actually trace a share in today’s marketplace, a single share could turn over 30,000, alright, in the course of a year.  So, what you really have is a bimodal distribution.  You’ve got a very large number of shares that are in effect frozen and sitting in your accounts and then you’ve got another smaller pool of shares that are turning over at a frantic pace.  You average that out, you get to a year.

But the reality in terms of voting power for you is if you actually had time based voting, the large majority of the institutions represented here would find their relative voting power increased, because most of you tend to hold your stock for a longer period of time and that would make you more powerful relative to the other shareholders.

Abe Friedman:

How does a board’s attitude around capital allocation change based on the kind of governance structure that they have in place?  Are boards thinking about capital allocation in different ways, in your experience, when they have dual-class structure in place?

Mark Lonergan:

You know, I’m reminded of the Mel Brooks movie The History of the World: Part 2.  At one point in the middle of the movie he turns to his guards and says, “Have him executed” and then he deadpans to the camera and says, “It’s good to be King.  Ah, it’s good to be King”.

I think that question of how it affects behaviour is an evolving story, I’m not sure we know quite yet. As a recruiter I can tell you that statured board members are increasingly unlikely to accept positions in dual-class voting companies because those positions are automatically described as advisory instead of governing.  And many of them, call it ego or call it whatever you like, many of them are reluctant to enter into situations where they’re not allowed to affect in a meaningful way, the direction of the company. As someone who’s done now several hundred public company board searches, I can tell you that that’s becoming increasingly an issue.

One other bit of context and I think this might be interesting for those of you who are not here in Northern California, the phenomenon that we’re now calling dual-class voting stock is actually reflected in the private markets as well, which is to say that many venture capital firms, are aggressively promoting, groups like Andreessen Horowitz and others, the notion of keeping the technology Founder in place as the CEO, as a precondition of its investment.  Which says that for the first time, that Founder, whether he or she has significant business operating experience in the past, is going to be allowed to remain at the helm of that company through an IPO and with the advent of dual-class voting stock, in fact, after the IPO as well.  The net effect is unclear; however, in that environment, board members, even Senior Management Team members, say its a very different dynamic, more like a family owned or a sole proprietorship, less like a thoughtful governed board and Management Team.

Aeisha Mastagni:

Mark, I think you bring up a really good point, because at CalSTRS we do look at companies that have these dual-class structures and we question the types of boards that are serving, because you wonder what kind of input do they really have? They don’t have an ability, to hold management accountable and the shareholders can’t hold them accountable.  I think that the Google example, the idea that you’re going to shoot for the moon and sometimes you’re going to miss, I think most investors are very accepting of one miss, two miss. It’s when it happens repeatedly one after another and you see our value in our shares just start to dissipate. That’s when we want the ability to hold folks accountable.

Larry Sonsini:

But what’s interesting about this oftentimes a dual-class structure leads to a more diverse independent board, because the fear of external disruption of the board is psychologically set aside because of the voting power. If you look at many dual-class, that’s the case. In fact, how many times does a business decision have to go to a shareholder vote?  Rarely.  The hiring and firing of a CEO doesn’t, all of the strategic transactions other than a change of control don’t. How many times do you have a proposition that is voted on that really affects the business strategy? So, we have to realise that you can have good accountability with a dual-class, you can have great diversity. An important fact in this is personality.  Who are these people; who is the CEO and who’s on the Board?  There are many situations where even though the CEO has the authority to do something, the CEO won’t make that decision until the CEO has careful consultation with other Directors. In many situations not all Directors are equal, there might be two or three Directors that are particularly influential on a specific topic and there are situations where CEOs decide not to proceed with a plan because of the advice that they get from people on the Board whose judgment that they trust.

Aeisha Mastagni:

Larry, you bring up a good point, because I don’t think the shareholders in the room want to vote on every transaction.  We see the board as our representatives inside the boardroom.  It’s when things, like I said, they’re right until they don’t go so right, that we want to be able to hold those Directors accountable and in these dual-class structures we have the inability to do so.

Larry Sonsini:

Well, I think you may, as a shareholder, but what boards really worry about are what their fiduciary obligations are and those obligations do not change in a dual-class structure.  I’ll tell you the truth, they have no material effect.  The bigger fact is the State Law and many States follow the Delaware concepts of the Business Judgment Rule. The judicial standard of the fiduciary duty in the United States really changes depending upon the circumstances.  So, for example, if you’re going to adopt a defensive measure such as a poisoned pill, you have an obligation to find a threat to corporate policy and to long-term value and to justify that that defensive measure is proportionate to that threat.  Or let’s say you’re going to sell the company, if you’re going to sell the company, for example, for all cash, you have a fiduciary obligation as a Director to find the best price. The only constituency is price, not what’s good for the Founders, what’s good for the employees, what’s good for the community and what’s good for the industry.  Now, what’s happened is many States have adopted statutes called constituency statutes that say in exercising your fiduciary duty you can take into account these other things. 

But the point I’m making is that boards are greatly influenced by their fiduciary duty obligations, not their dual-class structures and most boards in this country, notwithstanding the short-termism that we’ve experienced in the last ten years and notwithstanding the growth of dual-class, have become more independent.  There has not been a pushback against Independent Audit Committees, Independent Compensation Committees and let me tell you, if there are related party transactions with a controlling shareholder that has the high vote stock, more and more boards are willing to have special Committees of Independent Directors with Special Councils looking at those transactions.

I think that there’s a lot of overreaction to what the problem we’re trying to solve.  The problem is the short-term activism that has forced many US companies to spend 85% of net income buying back in shares and paying dividends, which it has not advanced the long-term business plan whatsoever, have reduced R&D costs, have not invested in other assets, because of this pressure. The reaction on dual-class is to that kind of pressure, if I have to spend all my resources to buy back shares, which is just financial engineering and has nothing to do with building long-term value, that’s not a good thing, I’m going to put it in a dual-class. That’s the confusion that we’ve got to get over.  We’ve got to understand the problem we’re trying to solve.

Abe Friedman:

On this question of return of capital, do you feel, as Intel as a public company with a more traditional governance structure, that Intel experiences more pressure around return of capital of the shareholders than, for example, a Google or Facebook or other companies with dual-class structure?

Suzan Miller:

I don’t know whether we’ve experienced more or less.  It is definitely a continual topic. We are a tech company that also does manufacturing which costs billions of dollars to put in place, it’s a constant work to keep people updated on why it is our capital is being used the way it is being used. A psychology industry is interesting, in that it is very internet time immediate, but also with very long development cycles. So, that dichotomy of running a tech company can cause confusion or cause difficulty in how you just explain your business to somebody who is outside of it.  But there is pressure and the pressure can only get really alleviated by the continual education of what we’re doing with the money and why we’re doing what we’re doing. I know a number of situations where there’s a reason why we’re doing something and it would be bad for the company and detrimental to the owners of the company to really explain all the details, because it would be giving away something that is not in the interests of the company to give away. You end up with that situation where your investors are uncomfortable with it and you can’t explain to them exactly why you’re doing it. 

Larry Sonsini:

The reality is that the traditional defensive measures that Corporate America used, classified boards, elimination of action by written consent of shareholders, elimination of the ability of shareholders to call special meetings of shareholders, really has had no effect on activism, the growth of proxy advisory firms, the power of many institutions to change governance structures.  Take the majority voting for Directors. You know, a substantial number of the Fortune 500 have a policy that if you, as a Director, do not get a majority of four votes, that you must tender your resignation, which may or may not need to be accepted.  And that has permeated Corporate America.

You add onto that proxy access and you add onto that that beneficial holders of shares who did not instruct their brokers on how to vote. Those basically means a small position in stock ownership has a big voice in the boardroom.  If you put all of those factors together and then you see the activism that’s come in the market that has led companies to say well, what other solutions do we have? That’s been the shift of the capital structure and I think we’ve got to bring that back into balance.

Audience Q&A

Peter Butler, Founder Partner Emeritus, GO Investment Partners LLP, UK:

The topic of multiple voting rights is very controversial, particularly in UK and Europe and we haven’t resolved our differences on that yet.  But I think the principle that we’re talking about is that we need, in some way, to encourage long-term shareholders and that will allow us to differentiate from the rights of a long-term shareholder as they stay on the register longer, compared with a short-term shareholder. If we actually think of the ways of doing that, of which multiple voting rights is one option, but let’s debate the other options, not today. I would like to suggest that instead of just having enhanced vote over a period of years, maybe there should be a right that, say, after four years on the register a shareholder was entitled to a small extra scrip share issue. 

What that would do would mean that the long-term holder would get a slightly extra vote, but he’d also get a higher dividend if he kept it, or if he wanted to sell it he’d get some cash. I think this could fundamentally change the dynamics of stewardship and activism, because of the passive investors that only charge a few basis points to their clients.  They don’t have much money for stewardship.  They all do as well as they can within the economics that they’ve got.  But if there was this long-term shareholders getting either an extra dividend of selling a scrip share, that could be shared between the Manager doing the stewardship and the owner. Effectively, the activist shareholder would become the agents for the long-term shareholder and that would put a discipline into the type of activism that was done, which would be in long-term interests.

Joseph Grundfest:

I think that’s a terrific idea.  I think the notion of experimentation of different types of benefits associated with different lengths of tenure, whether you do scrip, higher dividends so, the longer you’re in share, in Silicon Valley it’s very hard to be opposed to innovation. What’s really interesting is there’s been zero innovation in terms of voting mechanisms and the basic governance mechanism in publically traded corporations for the reasons that Larry’s pointed out.  We’ve had de facto regulation through the NASDAQ and the New York Stock Exchange that mandate one share, one vote and therefore we don’t have the opportunity to try these experiments.  I think it would be great to experiment and the only way we’re going to find out whether this stuff actually works is to try it.

Aeisha Mastagni:

But I think activists are blamed for being quote, unquote ‘short-term’.  You know, most of the activists in the CalSTRS portfolio have an average tenure in a stock of three/four/five, sometimes seven years.  That’s way longer than most mutual funds out there.

Theresa?:

I wonder is really public markets governance so onerous and so much more challenging than trying to convince your capital source [laughs] that you are still viable, you still have a good business operation and you still should be the one to lead the company?  Just love to hear your thoughts on that.

Larry Sonsini:

That’s a great question.  If you look at the terms of the securities that private capital is imposing upon companies that stayed longer private, it is much more restrictive than any dual-class and more expensive.  There are provisions about the voting power of a minority preferred stock exceeds that of any high vote stock provision.  The governance imposition on drag-along rights, tag-along rights, rights of first refusal, board seats, yes, that’s very true.  But the one difference is private capital is more bought in to the longevity of the business plan and public market capital really is not, quite frankly.  Now, there are long-term holders where there’s performance, but where there’s disruption there’s really a loss of patient. I’m not saying it’s a bad thing, but I think that’s a very important observation.  Be careful what you wish for in terms of staying private for 15 years and having to raise capital to build plan.

Abe Friedman:

T. Rowe recently announced that they were changing their proxy voting guidelines and they were going to vote against, I think, all boards of dual-class companies as long as they remain dual-class.  Do you think that’s going to have an impact and what do you see other investors doing on that topic?

Aeisha Mastagni:

Governance is an evolution, it’s certainly not static. We’ve talked about all of the things that have happened over the last 20 years and I think that there are examples in the marketplace that have investors re-examine how they look at these things.  At CalSTRS we look at our principles every year to determine what’s the best course for our beneficiary groups.

Voting Results