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Big Trouble in Little Markets: Unicorn IPOs and the Battle over Short-Termism

IPO season is in full bloom, as the procession of big-name (mainly) Silicon Valley unicorns find their way into public markets one way or another. It’s still early days, but things have gone pretty well for all parties involved. Bookrunners are making profits, companies are enjoying generally warm reception, and early-stage investors are crystalizing their paper returns. We are heartened to see that public market investors are delineating winners and losers (at least in the short-window of post-IPO activity) based upon the financial strength and cogency of tangible metrics presented. Growth machines with a path (or a stable footing) toward profitability are being rewarded handsomely. Remaining unicorns must see this as a generally positive trend, versus the fears of crashing valuations or rude awakenings that were bandied about for the last few years.

Not everything is goldilocks though, as there are rumblings from beneath the usual headlines about stock moves and disruptive technologies. Most of these rumblings are coming from the arcane corners of corporate governance, where an ideological divide between private market and public market participants has turned into a schism. It can best be summarized as a war between short-termism and long-termism, with variant beliefs behind the meanings of both terms. Ultimately, this comes down to the evolution of capital markets and what two opposing philosophies tell us.

Short-Termism and its Private Malcontents

The public markets receive a lot of flack from corners of the private market community. The usual attacks are around a focus on quarterly earnings, a fundamental misunderstanding of unit economics in a software-driven world, and the logistical burden of a reporting cycle on companies that are in scale-mode. These burdens can be a function of their operations as well as the psychology behind meeting expectations. It may be induced by war stories of activists, ousters, and an unrelenting financial news media.

Silicon Valley has griped about this for some time. Those gripes have turned into a proposed remedy, in the form of a new stock exchange, the Long-Term Stock Exchange (“LTSE”). Its founder (fabled SV guru Eric Ries), highlights the case for LTSE in this recent interview at the Code 2019 conference, a decidedly left-coast event. The ethos, according to Ries is about “a better experience for being a public company.” Going back to short-termism, Ries and his cohorts champion the inside perspective of the entrepreneur and apply it towards solving the issues high-flying startups consistently cite with public markets. In the interview, he lists key issues private companies have with capital markets today:

  • Aligning long-term vision of founders with shareholders
  • Providing multi-stakeholder rights beyond share price performance
  • Creating positive incentives for healthy development of technology

Ries cites the decades long decline in publicly listed companies as evidence of actual harm and believes LTSE is designed to address them and bring unicorns and other equidae to the party.

Good Governance and its Public Malcontents

Epsilon attended a governance panel this past week on the importance of crystalizing clearer investor stewardship guidelines. In attendance were behemoth asset owners (we were awkwardly out of place). A disconnect regarding responsible corporate governance clearly became apparent, at least between these large stewards of wealth and the private-market view preached by LTSE.

A framework for accountable corporate governance was discussed by the Investor Stewardship Group (“ISG”), which is self-described as “an investor-led effort that includes some of the largest U.S.-based institutional investors and global asset managers, along with several of their international counterparts. The members include more than 60 U.S. and international institutional investors with combined assets in excess of US$31 trillion in the U.S. equity markets… formed as a sustained initiative to establish a framework of basic investment stewardship and corporate governance standards for U.S. institutional investor and boardroom conduct.” ISG is a corollary to Commonsense Corporate Governance Principles (“CCGP”), a consortium led by Jamie Dimon and Warren Buffett (amongst others) striving for much the same. We’ve written about it in the past through the lens of short-termism. One of ISG’s core gripes is with dual-share classes, an increasingly popular tool used by private companies IPO’ing to ensure their founders can continue to control the vision of the company (one of LTSE’s stated objectives).

ISG is firmly against dual-share class structures. One of their six corporate governance principles states, “Companies should adopt a one-share, one-vote standard and avoid adopting share structures that create unequal voting rights among their shareholders.” CCGP is a bit more lenient (they state that “Dual class voting is not a best practice.”). The clear trend with en vogue tech IPOs has been maintaining founder control, and the tool for that has been dual-share class structures.

Headed for a clash?

On one hand, intermediaries for large pools of capital feel a responsibility to these corporate governance principles, especially as they are holding an increasingly large swath of voting responsibility for domestic equity markets. On the other hand, they don’t want to alienate the new wave of growth opportunities, which ultimately drive returns for their clients. This is a multi-player problem, with index providers and institutional investors in the middle or often overlapping in agency. 

LTSE hopes to address these issues through an entity providing structural competition. This entity is in the form of a listing exchange that can provide commercial access, addressing these issues through competitive choice. ISG seeks to form a consortium in order to address the collective action problem through a standard-setting body. Both approaches reflect a difference in philosophy.

Two Birds, One Stone?

While their prescriptives are contradictory, they’re both preaching the same thing! Looking beyond short-termism, ensuring proper governance, having a seat at the table for stakeholder views instead of short-term profits…the list goes on. Ries et al think that the founder’s vision is the kernel of value which – when cultivated carefully – gives fruit to the stakeholders of a company, and society writ large. It’s almost a Randian perspective on value creation. Sitting in the seat of a small “start-up”, I completely get it. Founders go through a lot and must be devout believes in their vision to have a chance at success. To relinquish that guiding star that got them so far feels like heresy in these circles.

ISG on the other hand thinks about it as the responsibility of the ecosystem (not any single company) and capital writ large to ensure the proper stewardship of resources across society. It’s almost the mirror political ideology, one of Leviathan. They view shareholder voting rights as a check towards corporate responsibility on compensation, irresponsible management, and functional capital markets holistically. They have seen founder turned tyrant and want to ensure that irreversible governance situations can be avoided so remedy can be effectuated. To reliquish standards on one-share-one-vote would feel like an abdication of parental responsibility.

Same problem, two sides of the ideological coin… Without imparting judgment, perhaps some instructive examples would be helpful in fleshing this out. Let’s take the case of Uber, perhaps the most influential of the unicorns. Uber waged a bloody internal conflict in ousting its charismatic founder/CEO prior to its IPO. Its shareholders thought it was necessary in order to successfully guide the company into the public markets, leaving behind some of the baggage of its adolescent mistakes. Would it have been able to do so had there been a supermajority of voting rights through a dual-share class governance structure? Conversely, historians look at Apple and the ouster of its charismatic founder/CEO Steve Jobs, as a characteristic mistake by short-term corporate interests. That mistake could have killed what ended up being a trillion dollar powerhouse.

Ultimately, stakeholders of all-kinds (entrepreneurs, capital stewards, exchanges, index providers, regulators!) need to get together and iron these issues out. Without picking sides explicitly, we can safely say that a lose-lose outcome would be a continuation of the status quo, which gives little room for future course-correction. Remember, these grumblings are coming to light with all-time-high indices in the tech/growth verticals, a situation where everybody should be happy. Imagine if these stocks were rapidly declining or (gasp) being disrupted by a new wave of companies. That would be real trouble…

Further Readings:

Corporate Governance by Index Exclusion (available via SSRN): https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3398578

Evolution or Revolution for Companies with Multi-Class Share Structures: https://corpgov.law.harvard.edu/2018/01/25/evolution-or-revolution-for-companies-with-multi-class-share-structures/

Inside the S&P 500: Multiple Share Classes and Voting (David Blitzer): https://www.indexologyblog.com/2013/12/06/inside-the-sp-500-multiple-share-classes-and-voting/

BlackRock, Vanguard and SSGA tighten hold on US boards (via FT): https://www.ft.com/content/046ec082-d713-3015-beaf-c7fa42f3484a

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