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Winston Churchill once quipped that “democracy is the worst form of government except for all those other forms that have been tried from time to time.” What is true for countries is usually true for companies, too.
Except lately. Corporate dictatorships are in vogue. Companies where founder-chief executives hold on to special voting shares, such as Meta Platforms and Alphabet, or run boards as their own personal fief, such as Elon Musk’s Tesla, are doing remarkably well.
One major stock market left behind by the dominance of the despots is London. Once a rival to New York, it has lost listings to the U.S., where founders can hang on to control using dual-class shares with extra votes, something hard to do in the U.K. Britain’s tight rules on related-party transactions also put off owners—such as SoftBank Group and Saudi Arabia—whose flagship listed companies often deal with linked firms.
Now Britain is changing the rules to attract more would-be corporate dictators. Its financial regulator this month is ditching shareholder protections in an effort to attract IPOs back to the venerable London Stock Exchange.
The hope is that owners of companies will like London more if they can maintain control, while management will like London more if they don’t forever have to ask pesky shareholders for permission for things.
The reality is that it probably won’t make much difference to London anytime soon, since London’s problems—now that its wild politics have calmed down—are mainly due to the lack of domestic investors in stocks. But the change demonstrates where power lies at the moment. Investors in the U.S. have been all too happy to buy companies where the founders have kept control, or act as if they did. Benign dictators are in fashion.
This isn’t necessarily a challenge to Churchill’s doctrine. True, it’s much easier to get stuff done when you don’t have to worry about re-election. But without democracy, leaders can’t be chucked out when they stop being benign.
The history of corporate success fits this model perfectly. Founders who manage to create, expand and list a company are usually pretty good. It isn’t surprising that shareholders like to give successful founders a free rein, avoiding all the usual corporate-governance restraints designed to prevent flights of fancy by a runaway CEO.
Founders also have skin in the game, in the form of a large part of their fortunes tied up in the stock, unlike the hired help who fill the C-suite at most big companies. Their flights of fancy might not always work out—Alphabet’s “moonshot” ventures have mostly lost money—but are part of the point of investing with a founder promising growth.
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The problems come later. Normally a CEO is constrained by the board, which is democratically elected by the shareholders. If the board doesn’t keep the CEO in line—classic mistakes include value-destroying takeovers and expensive new corporate HQs—directors may be ousted.
In companies that give extra votes to the founder, it becomes hard or impossible to change the board, let alone kick out the CEO. And if flights of fancy get out of control, or if the CEO starts running the company for his or her own benefit rather than for shareholders more broadly, there is little investors can do other than sell—as they did when Mark Zuckerberg, who controls Meta through special voting stock, pushed the company to spend billions of dollars on the “metaverse.”
Academics study this by looking at cases in which both voting and nonvoting or lower-voting shares trade. For the first dozen or so years after an IPO, corporate democracies and dictatorships tend to trade in line.
After that, the benefits of a benign corporate dictatorship wane, and the shares that have full voting rights trade at a significant premium, according to a 2019 study of 920 companies by Hyunseob Kim of the Chicago Federal Reserve and Roni Michaely of the University of Hong Kong and the European Corporate Governance Institute.
This makes sense. The interests of founders and outside investors are aligned when a company is small and fast-growing, as both profit mainly from its growth. Once it is big and slow-growing, the founder has less of an incentive to promote growth, and more reason to try to extract the benefits of control, such as by setting pay or awarding contracts. Their interests are no longer aligned.
London’s outright ban on dual-class stock has been tested by market forces and failed because companies simply listed elsewhere, usually on the Nasdaq. Britain will now have a corporate-governance regime that puts more onus on shareholders to protect themselves.
That is as it should be. But there are limits because so much money is passively run. Big pension funds in the U.K. liked the ban on dual-class shares and are now pushing index providers to tweak their rules to reduce index exposure to nonvoting shares.
“Active investors may be able to vote with their feet, but index investors are forced to buy the companies which are included in their index,” said Caroline Escott, acting head of sustainable ownership at Railpen, which manages pensions for railroad workers.
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The evidence from the U.S. is that once dual-class shares are in place, they’re hard to get rid of. In-demand IPOs will still be able to set their own rules, and founders like to keep control. The longer that high-profile companies with dual-class shares prosper, the harder it is to resist the idea that it isn’t a problem.
But dual-class shares will be a problem eventually. Shareholders need to worry about the founder’s children, and their children, still being in control in a few decades. One idea would be to demand robust sunset clauses on founder voting stock at the IPO. Sure, let the founder keep control for many years. But not forever.
The U.K. has set its rules so institutional pre-IPO investors can’t keep extra voting shares for more than 10 years after an IPO. The rules say nothing about founders, but might be a useful nudge to pension funds to insist on broader sunset clauses.
Democracy has drawbacks, but in the long run it is still the best we’ve got, for companies as well as countries.
Write to James Mackintosh at james.mackintosh@wsj.com
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