Yifat Aran is Assistant Professor of Law at the University of Haifa School of Law and Elizabeth Pollman is Professor of Law and Co-Director of the Institute for Law and Economics at the University of Pennsylvania Carey Law School. This post is based on their symposium article, Ousted, forthcoming in Theoretical Inquiries in Law. Related research from the Program on Corporate Governance includes The Untenable Case for Perpetual Dual-Class Stock (discussed on the Forum here) by Lucian A. Bebchuk and Kobi Kastiel; and Lucky CEOs and Lucky Directors (discussed on the Forum here) by Lucian A. Bebchuk, Yaniv Grinstein, and Urs Peyer.

In an era of “founder-friendly” startup governance, dual-class stock, and technology companies dominating public markets, founder-CEOs are both admired as visionaries and feared as potential governance problems. The entrenchment of founder-CEOs’ control via dual and multi-class stock sparks concern over possible agency costs and insufficient accountability for poor performance, which leads to suspicion that these founders might retain lifetime control. This concern has spurred advocacy for the implementation of sunset provisions and equal treatment agreements, designed to mitigate the risks of enduring control and to promote equal treatment for all shareholders. Amid the twists and turns of this debate, we observe that a small but important point is missing: a substantial number of founder-CEOs have been ousted—forced or pressured to step down from the CEO role despite maintaining important indicia of control.

In a new paper, we contribute to the ongoing debate by highlighting a range of factors that may erode the seemingly entrenched managerial control of founder-CEOs in both private and public companies. We use the term “ousted” in a broad sense, referring to scenarios where founder-CEOs, despite having carefully fortified their control, choose to resign amid pressure. Uber’s Travis Kalanick and WeWork’s Adam Neumann are both well-known examples, but there are also less-publicized examples like Peloton’s John Foley, Pinterest’s Ben Silbermann, and Blue Apron’s Matt Salzberg. These cases illustrate that contrary to the perception of founder-CEO entrenchment as an insurmountable barrier, there is a complex interplay of financial, legal, and personal factors. These are often magnified by public opinion and employee sentiment, which can persuade even powerful founder-CEOs to relinquish the helm. By studying these examples, we can gain a deeper understanding of the dynamics in these situations, which often bypasses the formal channels of activism that are typically prominent in discussions about corporate governance.

We begin by exploring how founders-CEOs become empowered or entrenched. Our study traces control allocation throughout tech companies’ life cycle, from their inception as venture capital-backed startups to their emergence as publicly traded firms. In the beginning, founders maintain control through majority voting rights and board seats, while investors are protected through staged financing arrangements, preferential cash flow rights, and protective provisions. As the company matures, the dilution of founders’ control in subsequent financing rounds is common, though not inevitable. Transitioning to public markets signifies a governance shift, one in which founder-CEOs have moved from historically structural weaknesses to pronounced strengths, especially before the recent tech downturn. In this period, a large number of founder-CEOs raised significant private capital while maintaining control of their companies. By one measure, when Google went public in 2004 with a dual-class structure, it was among only 3% of IPOs with such a structure, but by 2017-2019, 19% of all IPOs were founder-controlled dual-class firms, showcasing a marked shift towards founder-dominant firms.

Next, we note that as no conclusive evidence causally links dual-class structures with negative economic outcomes, the debate has remained unsettled, and dual and multi-class stock structures continue to be perceived as a contentious issue of corporate governance. Nevertheless, empirical evidence suggests a divergence in perception, as investors place a negligible discount or even a premium on these structures, contrasting with more cautious views or concerns raised by scholars and other observers.

What helps to explain investors’ reaction to these governance structures beyond a belief in founders’ idiosyncratic visions?  We argue that a variety of countervailing forces or factors can work to limit the durability of founder-CEOs’ managerial control in both private and public companies. Among these forces are poor stock performance, litigation with regulators and shareholders, employee and public pressure, as well as personal struggles and motivations. These factors can interact in complex ways, intensifying the challenges and complicating a founder-CEO’s ability to maintain their position. Ultimately, a founder-CEO who faces strong opposition is often better off stepping down from a leadership role than attempting to maintain managerial control.

For example, a decline in stock price and dissatisfaction with the company’s performance may build pressure on a founder-CEO to resign. An often-underestimated factor in this dynamic is the tendency of founders to enhance their liquidity and diversify their portfolios by securing margin loans against their shares. This practice allows founder-CEOs to maintain their voting rights, however, it also renders them susceptible to market volatility. A declining stock price not only erodes their wealth but may also threaten to trigger a margin call. In this situation, founder-CEOs may be motivated to step down not only to catalyze a stock price recovery but also so they may be able to liquidate more shares or pledge them post-departure.

To take another example, founder-CEOs facing legal pressure such as from regulatory violations or scandals may likewise come under scrutiny. Public outrage or poor financial performance in combination with such legal troubles can give the regulator a tailwind, and vice versa, regulatory actions can spark public outrage against the company and its leadership. Both dynamics can ultimately lead a founder-CEO to fall from managerial power.

Does this mean that dual and multi-class stock structures are not important? Certainly not. Although poor financial performance, legal exposure or scandals, and stakeholder pressure or personal struggles can put a founder-CEO in a tenuous position, such circumstances do not always dethrone them. There might be a tipping point or individual calculus that must be reached in circumstances where the founder-CEO has control and does not want to step down. Some founders, like Adam Neumann, were able to extract and destroy tremendous value on their way out by leveraging their stronghold over the company. Furthermore, the examples of Elizabeth Holmes of Theranos and Sam Bankman-Fried of FTX highlight that market forces, legal pressures, and personal accountability may not be sufficient to save a company in the face of fraud allegations or extreme governance failures. Moreover, it is important to note that even when a founder-CEO steps down, they may still retain significant control over the company such as by holding a significant percentage of the voting stock, or by serving as the board chairperson. Further, an ousting can be temporary—it exists at a particular moment and the founder may go on to have another act.

We conclude with implications of our analysis for the dual-class debate. Investors in high-growth companies often navigate the delicate balance between the risks of agency costs and the potential for substantial returns from rapidly growing companies. In cases where founder-CEOs abuse their control, investors may stand to lose their investment—capped at one times the initial amount. Yet, this outcome may be relatively rare as founders are human and still subject to guardrails in the form of pressure from regulators, investors, employees, and the general public. Financial performance problems, legal concerns, employee and public backlash or activism, as well as personal struggles or other motivations, can ultimately push them to relinquish the top executive role. Conversely, if the founder is an effective and visionary leader, then shielding them, at least partially, from market forces to execute their vision could help result in returns far exceeding the original investment. Consequently, public market investors in a diverse portfolio of venture-backed firms going public may justifiably assign a minimal discount or even a premium to dual-class stock structures.

The complete paper is available for download here.

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