Many have recently lamented the decline in the number of IPOs and public companies generally (about half the number since the boom in 1996), and numerous reasons have been offered in explanation, from regulatory burden to hedge-fund activism. (See this PubCo post and this PubCo post.) In response, some companies are exploring different approaches to going public, leading to a resurgence in SPACs and the launch of IPOs as “direct listings,” which avoid the underwritten IPO process altogether. At the same time, companies are seeking ways to address some of the perceived drawbacks associated with being public companies—including the pressures of short-termism, the risks of activist attacks and potential loss of control of companies’ fundamental mission—through dual-class structures and other approaches. Even the SEC is currently planning a roundtable to address the causes of and potential solutions to short-termism. (See this PubCo post.) Changing dynamics are not, however, limited to the IPO process itself. And one of the most interesting concepts designed to address these issues on completely different turf was just approved by the SEC this month—a novel concept for a stock exchange located in San Francisco, the Long-Term Stock Exchange. The concept has been in the works for a couple of years now and is backed by some heavy-hitting investors. According to the LTSE’s founder and CEO, the “IPO is like a wedding. The IPO process is, what kind of wedding planner do you hire? What kind of wedding do you want to have? But being a public company is you’re now married to the public markets for the rest of your life. People have mostly focused on the IPO process — it’s like making the wedding more efficient….That’s not the problem. The problem is we have to live like this forever.” How will the new Exchange seek to improve this “married life” going forward?
According to the CEO of the Exchange, the “similarity between the…Long-Term Stock Exchange and the roughly 15 other stock exchanges that are expected to host trading between now and the end of next year ends with the word ‘exchange.’” What started as a more of a pipedream—and one designed to entice someone else to take up the challenge—is expected to begin accepting listings and to “start trading later this year after completing administrative and technical steps.” The concept is to offer, through listing standards and other tools, a “new approach to governance designed for the mutual benefit of companies and investors.” In particular, LTSE’s founder said that he discovered in his conversations with entrepreneurs that many were reluctant to go public. Why? Always for the same reasons: “managers are concerned. Concerned about losing control of their company. Concerned about having to manage to the quarter. Concerned about compromising the company mission. Concerned about the distractions that take energy away from serving customers and creating value. Concerned about being punished by the markets for investing in anything other than driving short-term metrics.” What was needed, he decided, was “a new public securities exchange designed to promote long-term value creation.” The new exchange would “craft a new bargain between great companies and long-term-oriented investors that share the collective goal of innovation and value creation.”
While the LTSE will certainly “be a marketplace for buying and selling shares of listed companies,” the Exchange’s CEO explained, the LTSE expects that when companies list shares for sale to the public, “they will adopt a set of governing practices that are designed to help them build lasting businesses and empower long term-focused shareholders. For example, we expect that companies listed on LTSE will, among other things, develop indicators of progress toward long-term success and link executive pay to long-term performance. And that they will disclose investments in long term-focused research and development, and explain their approaches to community, diversity, and the environment.”
As noted in the SEC’s approval order, the LTSE’s application received one comment letter—from the Council of Institutional Investors. CII objected to approval on two bases: first, that the Voting Rights Policy would allow newly public companies to have multi-class structures with unequal voting rights and, second, LTSE’s reported plan to permit “time-phased voting,” sometimes referred to as “tenure voting.” TPV, which some view as a mechanism to deter short-termism, means that long-term holders would have incrementally more voting power than short-term holders. With regard to TPV, CII was concerned that the tenure voting rights would present technical challenges in tracking ownership of those with super-voting rights and also result in disproportionate empowerment of founders, particular long-term institutional investors and governments with an equity stake. However, the SEC concluded that LTSE’s corporate governance standards were “substantially similar to the corporate governance listing standards of other exchanges, such as the NYSE and Nasdaq, including its Voting Rights Policy. With respect to CII’s concerns about tenure voting rights, the SEC noted that the LTSE had not yet proposed those rights and that, as a registered exchange, it would be required to file with the SEC any changes to its rules as a proposed rule change, allowing for public notice and comment.
Tenure voting, discussed in this PubCo post from 2015, is a technique resurrected from the 1980s that some believe could be used to repel hedge-fund activists and other short-termers. The concept would give investors additional votes if they hold their shares for at least a specified period of time, thus rewarding long-term holders by giving them more say in the future of the company than, say, short-term hedge fund activists that may favor short-term profits over long-term business strategies. The concept was reportedly invented during the 1980s in response to a wave of hostile takeover attempts. Perhaps the first company to implement this approach was J.M. Smucker Co., which adopted a tenure voting plan as a shareholder protection measure. Under the plan, existing shareholders received ten votes for each share held. However, upon transfer, these shares would revert to one vote per share, but would regain super-voting status if they were held for 48 consecutive months. In 1996, in Williams v. Geier, the Delaware Supreme Court upheld adoption by the board of a similar plan as a proper exercise of the business judgment rule to promote long-term planning (even though the effect of the plan was to concentrate voting rights in hands of a controlling block); the plan was then approved by a fully informed shareholder vote, which was considered dispositive.
According to Reuters, the “new exchange would have extra rules designed to encourage companies to focus on long-term innovation rather than the grind of quarterly earnings reports by asking companies to limit executive bonuses that award short-term accomplishments. It would also require more disclosure to investors about meeting key milestones and plans, and reward long-term shareholders by giving them more voting power the longer they hold the stock.” With regard to the expected tenure voting proposal, however, thestreet.com reports that the founder acknowledged that it’s “likely that the tenure voting proposal, which is controversial among many market watchdogs, will need to be revised.”
And in an interview in VOX, LTSE’s founder and CEO maintained that excessive concentration on the short term has skewed many companies’ focus: “short-term stock price increases—beating quarterly projections by Wall Street analysts, shrinking extraneous budgets for research and development to cut costs, and tangling with activist investors who want to nip and tuck to create extra margins.” The hope is that, with a new set of governing principles and different relationships with institutional investors, companies listed on the LTSE will be better positioned to emphasize the long term. Although investors in companies listed on the LTSE will not have a contractual limitation on their ability to sell shares at any time, including short sales, company management would have an “understanding” with these investors that they intend to hold for the long term. According to the article, the founder also wants to “see executive compensation packages change so they’re not as incentivized by bonuses for beating certain short-term targets but rather through long-term vesting schedules—as long as 10 years. Those are the sort of requirements that companies would have to enshrine to be listed on the LTSE.” The LTSE founder also advocates that companies look beyond the shareholder preeminence theory—the theory that the purpose of corporations is to maximize shareholder value—to take into account other constituencies: in his view, “a CEO should be responsible for things beyond just a higher stock price. She or he carries responsibilities to their local communities, to their employees, and to their partners. So that’s why companies listed on the LTSE are expected to have to have board-wide committees that focus on things like commitments to sustainability or diversity.” And corporate boards, he believes, should be thinking about “more than…audit and compliance,” but also about a bigger picture with a longer term focus. Whether companies will take the risk of signing up for this new Exchange remains to be seen.
Some academics have maintained that, during the booming economy of the decades after World War II, the interests of companies and a broad range of constituencies were in sync. During that period, many companies acknowledged their responsibilities to balance profits and the interests of employees and the community. The shift to shareholder primacy has been widely attributed to the development of the “shareholder preeminence theory” by the Chicago school of economists, beginning in the 1970s, with economist Milton Friedman famously arguing that the only “social responsibility of business is to increase its profits.” Subsequently, two other economists published a paper characterizing shareholders as “‘principals’ who hired executives and board members as ‘agents.’ In other words, when you are an executive or corporate director, you work for the shareholders.” (See this PubCo post.)
Although the shareholder preeminence theory still largely holds sway in the U.S., it has recently come under more critical scrutiny—and from what might otherwise seem unlikely sources. For example, in his last two annual letters to public companies, Laurence Fink, the Chair and CEO of BlackRock, has advocated that companies recognize their responsibilities to stakeholders beyond just shareholders—to employees, customers and communities—as part of an overall focus on the long term. In his 2018 annual letter, Fink suggested that governments have just not been up to the task of addressing the many challenges afflicting society, with the result that “society increasingly is turning to the private sector and asking that companies respond to broader societal challenges…. To prosper over time, every company must not only deliver financial performance, but also show how it makes a positive contribution to society. Companies must benefit all of their stakeholders, including shareholders, employees, customers, and the communities in which they operate.” [Emphasis added.]
What does that mean in practice? According to Fink, among other things, a company should consider its role in the community, its management of its environmental impact, its efforts to create a diverse workforce, its ability to adapt to technological change and take advantage of new opportunities, its retraining programs for employees in an increasingly automated world and its efforts to help prepare workers for retirement. But these goals are not just goals in and of themselves; they have a larger purpose. In the absence of “a sense of purpose,” Fink contends, companies will simply “succumb to short-term pressures to distribute earnings, and, in the process, sacrifice investments in employee development, innovation, and capital expenditures that are necessary for long-term growth. It will remain exposed to activist campaigns that articulate a clearer goal, even if that goal serves only the shortest and narrowest of objectives. And ultimately, that company will provide subpar returns to the investors who depend on it to finance their retirement, home purchases, or higher education.” (See this PubCo post and this PubCo post.)