May 14, 2011
LinkedIn's IPO: Debating the Corporate Governance Structure
Following up on Josh's post about the teaching opportunities presented by the Ed Shultz lawsuit, I thought I'd summarize some of what Steven Davidoff and John Carney have recently written about the planned LinkedIn IPO, which also has the potential to serve as a useful teaching case study.
Davidoff has posted a couple of pieces over at DealBook discussing what he sees as a number of management-friendly governance structure provisions. In the first, he focuses on the proposed dual-class structure, which would essentially allow co-founder Reid Hoffman to retain control of the business even if his ownership stake drops significantly below a majority. This is so because he will own Class B shares that carry 10 votes as opposed to the one-vote Class A shares being offered to the public. Notes Davidoff:
In 1988, the Securities and Exchange Commission responded to shareholder complaints by trying to outlaw dual-class stock, but the rule was struck down a year later by a federal court. The stock exchanges then adopted their own rules forbidding a company from adopting dual shares after it listed. This ended the ability of management to adopt this structure to fight off a hostile bid. The exchanges, however, allowed a big exception: a company can go public with a dual-class share structure.
The tension here, of course, is between (a) the benefits of allowing those who have successfully managed the business to the point of making it IPO-worthy to continue to exercise control even after significantly reducing their equity stake, and (b) effectively disenfranchising public shareholders in a way that creates opportunities for value-destroying self-dealing. Here, Davidoff points out that:
A study in 2008 by Paul A. Gompers, Joy L. Ishii and Andrew Metrick found evidence of this self-interest. The authors found that dual-class stock could destroy value where the holders had a much more significant voting interest than an economic one.
One obvious response to the criticism of dual-class stock is that the market will take the structure into account in valuing the offering. In making this point, Carney points out that the market may actually have some good reasons to favor such a structure:
[W]hat Davidoff and the governance types don't see is that "good" corporate governance may be too costly for its alleged benefits. And government policy is constantly making it costlier. Consider, for instance, recently proposed changes in proxy access rules and "say on pay." These increase the ability of special interest groups, including union-controlled pension funds, to cut deals with management to the detriment of outside shareholders. Dual class companies may avoid this problem. Similarly, dual class companies can better avoid the short term "beat the quarter" thinking that debilitates so much of corporate America.
Davidoff notes, however, that there may be reason to question the market's efficiency on this point:
Why is LinkedIn adopting these mechanisms? The most likely reason is that it can get away with it, particularly since this will be a hot I.P.O. Institutional Shareholder Services, the influential proxy advisory service, does not provide a rating of corporate governance until the company is public. The reason is that many of I.S.S.’s customers — institutional shareholders — are going to flip shares acquired in an I.P.O., and therefore do not scrutinize the company’s corporate governance provisions at the going-public stage.
In my opinion, this is just another area where we likely need more empirical evidence of investor behavior. I imagine behavioral economists would be able to identify a number of cognitive biases that set up investors to undervalue the risk of a variety of corporate governance structures.
In his second piece, Davidoff goes on to examine a number of other potentially problematic features of LinkedIn's corporate governance structure, including the presence of a staggered board (which Davidoff notes is effectively permanent in light of the dual-class structure and relevant voting requirements), bylaw notice / choice of forum provisions, and acceptance of Delaware's anti-takeover statute protections.
All in all, there is easily enough here to fill an entire review session at the end of a Corporations class.
I think this is a really interesting subject - I wonder how it'll affect other IPOs for websites?
Posted by: Jack | May 14, 2011 11:23:21 PM