Will Tenure Voting Give Corporate Managers Lifetime Tenure?

Paul H. Edelman is Professor of Mathematics and Professor of Law at Vanderbilt University; Wei Jiang is Arthur F. Burns Professor of Free and Competitive Enterprise at Columbia Business School; and Randall S. Thomas is John S. Beasley II Chair in Law and Business at Vanderbilt Law School. This post is based on their recent article, forthcoming  in the Texas Law Review. Related research from the Program on Corporate Governance includes The Untenable Case for Perpetual Dual-Class Stock by Lucian Bebchuk and Kobi Kastiel (discussed on the Forum here).

In the past decade, many household name companies, including Alibaba, Facebook and Google (now Alphabet, Inc.), have adopted management-friendly dual-class voting systems justified as giving their executives the freedom to operate the companies toward long term value maximization and sheltering them from shareholder pressures for short-term outcomes. However, many institutional investors dislike these structures because they insulate managers from shareholder monitoring and create impenetrable obstacles to change of control transactions. In reaction to pressure from these large shareholders, the S&P 500 recently decided to bar newcomer companies with multiple classes of shares from its flagship index.

Tenure voting, that is, a system that awards greater voting power to shares held for a longer duration, has arisen as an alternative voting system that could satisfy both corporate managers’ desire for consistent control and simultaneously give long-term investors a greater role in these firms’ governance than at firms with dual-class equity structures. While there are relatively few public companies in the U.S. (e.g., Aflac, Inc.) that employ it, several European jurisdictions (notably France) have enthusiastically embraced tenure voting to a far greater extent. Moreover, the burgeoning blockchain technology could make it much easier to enforce a tenure voting system as it allows companies to trace the identity of their shareholders and therefore more accurately assign high and low voting rights.

Is tenure voting really the best of both worlds and can it shelter the management from shareholder challenges? In this article, we build a simulation model that estimates the probability of votes favoring management given the distribution of shares among seven constituencies with different investment horizons, and assumptions of the influence of third party proxy services on those constituencies. Among the shareholder constituencies in our model, Management and Dissident are opponents, and we assume that the Public (non-institutional) shareholders have a pro-management bias. Finally, the four types of Institutions are partitioned by whether their investment horizon meets the tenure voting threshold, and whether they closely follow the recommendations from a leading proxy advisor such as Institutional Shareholder Services (ISS). Our model allows both concentrated ownership with high insider ownership (baseline of 30%) and dispersed ownership with low managerial stakes (baseline of 3%). The baseline ownership for the Dissident is set to be 10%, and the ownership of long-term investors vary from 20% to 40%. All the figures are calibrated to empirical regularities. Finally, we consider both 3-1 and 10-1 superior voting rights for tenure-phased shares.

Two main findings came out of the simulation. First, when corporate management holds a large block of company stock prior to the implementation of tenure voting, and retains at least 20-30% of the total number of company shares on a long term basis, then tenure voting will insure that corporate managers maintain control of the company even in the face of an attempted change of control transaction by a highly motivated dissident shareholder who owns the maximum amount of stock permitted by most poison pills. From institutional investors’ perspective, giving corporate management control while forcing them to maintain a substantial stake in the company (and thereby keeping a continuing strong financial incentive to maximize shareholder value) as the price of control is likely to be preferable to dual-class voting systems in which public shareholders enjoy low or virtually no votes, because dual-class exclusively allows corporate management to maintain control even at negligible ownership levels.

Second, if corporate management chooses to sell off its large initial block of the company’s stock over time, so that inside ownership levels eventually drop down to a low percentage level with the majority of ownership held by institutional shareholders with different investment horizons, then the use of tenure voting systems does little to protect management control in a proxy contest for corporate control. Moreover, it is likely to lead to a transfer of voting power to passive shareholders who often delegate their vote to ISS, and therefore leading ISS to “sway” even more votes than they do today. This finding is robust to a wide variety of assumptions about stock ownership levels, shareholder voting preferences and the degree of influence of third party voting advisors.

In conclusion, tenure voting indeed represents an intermediate form of voting control from a managers’ perspective: it does not guarantee management control, as dual-class share structures do, but does give control to management who maintain large equity stakes in the firm. Institutional investors are likely to see it as an improvement over dual-class stock structures in terms of giving them corporate governance rights, although less advantageous to these shareholders’ rights than a one share, one vote voting system.

Tenure voting could also be a preferable compromise to recent proposals for time limited dual-class voting schemes. One of these proposals would limit the life of dual-class voting structures in order to insure that companies were required to hold a second shareholder vote to extend the life of a dual-class structure. While this approach has the advantage of requiring fresh shareholder input on whether to continue the existence of a dual-class system, it also significantly weakens management’s control rights and potentially limits its ability to engage in long term management practices. Tenure voting with a committed large management blockholder would preserve management control and give shareholders the benefit of a well aligned controlling shareholder.

The full article is available for download here.

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