Coinbase plans to go public in April highlights a disturbing trend among tech corporations: The company’s founding team will retain voting control, making it largely immune to the wishes of outside investors.
The the most famous American cryptocurrency exchange does this through creating two classes of shares. One of the classes might be open to the public. The second is reserved for founders, insiders and early investors and will have 20 times the voting power of common shares. That way, when all is said and done, insiders will own 53.5% of the votes.
Coinbase will join several dozen other technology corporations listed on the stock exchange – many of them have household names like Google, Facebook, Doordash, Airbnb and Slack issued two types of shares trying to keep control for founders and insiders. The reason this is becoming more and more popular has a lot to do with it Ayn Rand, one of Silicon Valley’s favorite authorsand the “founder myth” that her writings helped encourage.
Committed investors and management experts as I they typically dislike dual-class actions because they undermine management accountability, making it harder to rein in a recalcitrant CEO. I first got here across this method that managers use to limit the influence of intrusive outsiders when working on my dissertation on hostile takeovers in the late 80’s.
However, the risks of this trend are greater than merely perpetuating poor management. Today, given the role that technology corporations play virtually every corner of American lifeit also poses a threat to democracy.
Everything in the family
Two-class voting structures have existed for many years.
When in 1956 Ford Motor Co. went public, the founding family took advantage of this arrangement maintain 40% of voting rights. Press corporations as New York Times AND Washington Post. they often use this arrangement to protect their journalistic independence from Wall Street’s insatiable demands for profitability.
In a typical dual-class structure, the company will sell one class of stock to the public, normally called Class A shares, while the founders, directors and others retain Class B shares with enough voting power to maintain majority control. This allows Class B shareholders to determine the final result of matters subject to a shareholder vote, akin to who serves on the company’s board of directors.
Proponents see the two-class structure as a way to stave off short-term considering. In principle, such insulation from investor pressure may allow the company to do so take a long-term perspective and make difficult strategic changes even at the expense of short-term share price declines. Family businesses often see this as a way to preserve their legacy, which is why Ford stays a family business after greater than a century.
This also creates a company effectively turn out to be immune to hostile takeovers and the whims of activist investors.
Checks and balances
But this isolation comes at a cost to investors, who lose crucial management control.
Indeed, dual-class stocks are essentially shorting just about all other measures limiting executive power. The board of directors, elected by shareholder vote, is the highest body in a corporation that oversees management. Voting for directors and proposals in the annual ballot are the important methods by which shareholders must ensure board accountability, apart from simply selling their shares.
The latest research shows that the value and stock returns of dual-class corporations are lower than those of other corporations, and that they are more likely to overpay their CEO and waste money on expensive acquisitions.
Companies with dual-class shares rarely accounted for greater than 10% of public quotations in a given 12 months until the first decade of the twenty first century, when technology startups began to use them more often – according to data collected by University of Florida business professor Jay Ritter. The dam began to break after Facebook went public in 2012 dual-class inventory structure what kept founder Mark Zuckerberg under tight control – he himself controls almost 60% of the company.
In 2020, greater than 40% of technology corporations that went public did so with at least two classes of shares with unequal voting rights.
This was disturbing management experts, some investors AND law experts.
AP Photo/Andrzej Harnik
Ayn Rand and the myth of the superhuman founder
If a dual-class structure is bad for investors, why do so many tech corporations manage to persuade them to buy their shares once they go public?
I attribute this to Silicon Valley founder mythology – what I might call “Ayn Rand theory of corporate governance,” which attributes founders with superhuman vision and competence that deserve respect from lesser mortals. Rand’s novels, especially Atlas Shrugged, depict an America in which business titans keep the world going by creating innovation and value, but are plagued by vagrants and robbers who want to take over or regulate what they have created.
Perhaps not surprisingly, Rand has many supporters among them technology founderswhose creative genius could also be ‘at risk’ through any form of external regulation. Elon Muskfounder of Coinbase Brian Armstrong and even late Steve Jobs everyone advisable “Atlas Shrugged.”
AP photo
Her work is also appreciated by enterprise capitalists who normally finance technology start-ups – many of whom were the founders themselves.
The basic idea is easy: only the founder has the vision, charisma and smarts to take the company forward.
It begins with a powerful founding story. Michael Dell and Zuckerberg created their multi-billion corporations in their dorm rooms. Founding pairs Steve Jobs and Steve Wozniak and Bill Hewlett and David Packard built their first computer corporations in the garage – Apple and Hewlett-Packard, respectively. Often these stories are true, but sometimes, as in the case of Apple, less so.
Founders then face rigorous tests: recruiting collaborators, accumulating customers, and, perhaps most significantly, raising multiple rounds of financing from enterprise capitalists. Each round is used for further confirming the founder’s leadership skills.
Founders Fund, a enterprise capital firm that has backed dozens of tech corporations including Airbnb, Palantir and Lyft, is one of the biggest proponents of this myth because explains this in his “manifesto”.
“The entrepreneurs who create it have an almost messianic approach and believe that their company is necessary to make the world a better place,” he assures. True to its beliefs, the fund says it has “never removed a single founder” and has subsequently been a strong supporter of dual-class share structures.
Another enterprise capitalist who seems to favor giving the founders additional power, gave the founder of Netscape Marc Andreessen. His enterprise capital firm Andreessen Horowitz is owned by Coinbase largest investor. And most of it corporations in its portfolio that went public also used a dual-class share structure, according to my very own review of their securities filings.
Bad for corporations, bad for democracy
Giving founders voting control disrupts the checks and balances crucial to maintain accountability in the business and can lead to serious problems.
WeWork founder Adam Neumannfor example, it demanded “unambiguous authority to dismiss or remove any director or employee.” As his behavior became increasingly erratic, the company burned through money in the run-up to the ultimately canceled initial public offering.
Investors ousted Travis Kalanick from Uber in 2017, but… not before he is said to have created workplace culture which allegedly enabled sexual harassment and discrimination to spread. When Uber finally went public in 2019, abandoned its two-class structure.
Is some evidence that founder-directors are less talented at management than other types of leaders, and their company performance may consequently suffer.
However, investors buying shares of these corporations are aware of the risks associated with them. There is much more at stake than simply their money.
What happens when powerful, unconstrained founders control the strongest corporations in the world?
The technology sector does claims are being made more and more often to the central command posts of the American economy. Americans’ access to news and information, financial services, social networks, and even groceries is mediated by a handful of corporations controlled by a handful of people.
Recall that in the wake of the January 6 Capitol rebel, Facebook and Twitter executives were able to kick former President Donald Trump off his favorite means of communication – practically silencing him overnight. AND Apple, Google and Amazon cut off Parler, a right-wing social networking site where some insurgents plan their actions. Not all of these corporations have dual-class shares, but it illustrates how much power tech corporations have over American political discourse.
You don’t have to disagree with their decision to see that some form of political power is increasingly concentrated in the hands of corporations subject to limited external oversight.
[ Sign up for The Conversation’s newsletter.]