Et tu, Google?April 27, 2012: 11:52 AM ET
Google's founders recently announced a new corporate structure designed to perpetuate their grip over the company. Everyone should beware.
FORTUNE -- Google's founders announced a plan designed to perpetuate their ironclad grip on the long-term governance of the company.
With the board's blessing, the company will issue a new non-voting class of shares to existing shareholders. Because the founders currently hold majority-voting rights, the plan does not require that shareholders give their consent to the dilution of their future voting power. The action comes amid ongoing stock sales by Google's (GOOG) founders.
While this edict by the founders is important to Google stockholders, users of Google's products, and owners of other stocks -- outright or in mutual funds or retirements savings plans -- should also beware.
Other technology firms, like Facebook, and financial firms, like Carlyle, are attempting to gain access to public market funding without giving shareholders a mechanism to keep the founders accountable. In a conference call with analysts on April 12, Google CEO Larry Page took credit for a similar lack of voting rights at other companies. "Given Google's success, it's unsurprising this type of dual-class governance structure is now somewhat standard among newer technology companies," he said.
But not everyone buys the "if everyone is doing it, it must be a good idea" argument. Even those with short memories can recall the tech boom and bust at the turn of the last decade, or the financial crisis we are still digging out of.
Google's founders marshaled the best possible arguments for their plan in a letter to shareholders. Taking a swipe at shareholder governance, they argued that evading shareholder mandates was the best way to keep the company focused on the long term.
The founder's invocation of the long term was genius. After all, no one in her right mind goes around saying we believe in the short term and the long term be damned. People may act in favor of their own short-term selfish interests but saying so is an inevitable invitation to cries of foul play.
So it isn't too surprising that the founders' arguments have convinced some. With Google, shareholders are buying their founders and their ability to create value, says Rob Jackson, a professor at Columbia Law School. While shareholders may have expected the founders to loosen their control over time, they "went into the stock with their eyes open," he says.
However, many founders do falter. "Google is definitely a genius-based company," wrote Bob Monks, chair of LENS Investments, in an email. "The question needs to be raised is their failure in the 'social market' an indication of the end of genius, a la Edwin Land, Polaroid's founder. Or is it a hiccup in the style of Bill Gates who launched the Office Suite at the same time as gathering his senior staff to obsolesce the whole technology by going to the web…. Some mechanism must exist to permit outside shareholder reevaluation of the 'locked up' voting control," he wrote.
John Whitehead, retired co-chair of Goldman Sachs (GS), says that he is a strong believer in one share one vote. "Some managements do a good job. And those who do a good job don't need special voting arrangements," he says. "And those who do a bad job need active voting by shareholders to keep them in check. There is no argument to be made for special voting arrangements at Google or anywhere else," he says.
The Council of Institutional Investors, an association representing funds and managers with over $3 trillion in assets under management, is "no fan of dual class shares or entrenched founders. We believe in one share one vote as a fundamental right of shareholders," says Ann Yerger, the council's executive director.
The baseline for good governance worldwide is the OECD governance principles, which were adopted in 2004 by the U.S.and 29 other countries. The actions at Google, Facebook and Carlyle all fly in the face of sections two and three of those principles, which describe the rights of shareholders. Some may argue, "So what -- what is a lapse in principles among friends?"
But this issue goes beyond dollars and cents. The FCC gave Google a $25,000 wrist-slap for an inadvertent drive-by theft of personal information. A Google spokesperson said in an email, "It was a mistake … but we believe we did nothing illegal." The FTC may be readying an anti-trust case, but can we really trust Google's founders with this kind of power, especially given the apparent weak will of regulators to protect individuals from Google's and other tech firms' privacy breaches?
Who could check Google's authority? Yerger says there are four ways to halt public market investment in the Googles, Facebooks, and Carlyles of the world. First off, the exchanges could refuse to list them. Or the indexes could refuse to include them. The investment banks could refuse to underwrite them. And those who invest other people's money -- so-called fiduciaries -- could refuse to invest in them.
Unless investment banks refuse to underwrite these kinds of shares, as they should, companies will continue to use them, Whitehead says.
Both Monks and Whitehead agree that fiduciaries, who are obligated to protect the invested dollars entrusted to them, should not invest in these kinds of stocks due to the risks involved. But firms like Blackrock and Fidelity certainly are investing large amounts of other people's money in Google, according to the tech giant's preliminary proxy filing. And for now, it appears that other fiduciaries are not engaging with Google on the voting rights issue either.
One share, one vote is a "psychologically important part of the free enterprise system," which helps to encourage market participation, Whitehead says.
The erosion of that trust weakens the market for all stocks.
Google founders see themselves as pioneers in stripping accountability from the capital markets system. But, to quote the company's own motto, you can make money without doing evil. If Google's founders intend to do good, accountability should be no obstacle.
Eleanor Bloxham is CEO of The Value Alliance and Corporate Governance Alliance (http://thevaluealliance.com), a board advisory firm.