Wednesday, March 24, 2021

CII urges senators to sunset dual-class stock provisions, require diversity disclosure

By Amanda Maine, J.D.

In a recent letter to the chairman and ranking member of the Senate Banking Committee, the Council of Institutional Investors (CII) recommended the adoption of legislation requiring a sunset period for companies that issue dual-class stocks. CII also voiced its support for the Improving Corporate Governance Through Diversity Act of 2021 (S. 374), which would require disclosure of the diversity of a company’s board of directors and senior executives.

Dual-class sunset provision. CII’s draft legislation, the SEC as Investor Advocate Act of 2021, would require U.S. companies that are listed on the main exchanges include a "sunset provision" for issuances of stock that carry multiple votes per share. CII acknowledged that the multi-stock structure is favored by tech startups as a means of providing "visionary founders" of companies such as Google and Facebook with the time and space needed to execute that vision. However, CII argued that not every startup is Google or Facebook and cited research criticizing unchecked grants of unequal voting power over time.

Exchanges currently permit the listing of shares with two or more classes of stocks, CII advised: "Class A" shares held by the public, and "Class B" shares held by the company’s founders and other insiders, with Class B shares entitled to multiple votes per share compared to one vote per share for Class A stock. According to CII, the owners of Class B shares have effective control even if they own only a comparatively small number of shares. In the medium to long-term, this can result in lack of shareholder accountability, CII opined.

To address this problem, a "logical compromise" is to put in place a sunset mechanism on multi-class voting structures, CII stated, suggesting a sunset of seven years or less that it feels would offer an appropriate period to harness the benefits of innovation while mitigating the agency costs a business would incur over time. CII also noted that a limited but growing number of multi-class companies have incorporated sunset provisions into their charters as part of their IPOs, ranging from three to 20 years but with most in the range of seven to 10 years.

CII said that the sunset approach would give startups "running room" for founders of companies that use the multi-class structure while benefiting investors who want to invest in a company whose vision they support, whose founders deserve a measure of freedom, and yet will benefit from their own share ownership once the startup phase has passed. CII also noted that the proposed legislation contains a "safety valve." Under this provision, a founder can make his or her case to the shareholders for extending the seven-year startup period.

Diversity. CII also expressed its support for a bill requiring disclosure of the composition of a company’s board of directors, its nominees for director positions, and executive officers. CII noted that the draft legislation would require the disclosure of data based on voluntary self-identification of racial, ethnic, and gender composition of a board of directors and the company’s nominees. CII cited studies that have concluded that diverse boards can have a significant positive effect on a company’s financial performance. CII’s letter also notes that diverse boards can be achieved without quotas that result in "check-the-box diversity."

In support of requiring disclosure of board diversity, CII remarked that this information is important to investors, yet difficult to obtain. CII also noted that there is an extensive body of empirical research that demonstrates diverse boards are positively associated with good corporate governance as well as company performance. In addition, CII advised that the costs to companies making this disclosure should be minimal in light of the benefits to investors who desire this information.