One of the hardest problems in any organization, whether a democratic government or a corporation, is figuring out how to strike a balance between short-term interests and long-term goals. For some companies — especially product-centric tech companies led by founders — one solution has been the creation of dual-class, or tiered, share structures, which give founders and other insiders more voting rights than other holders of the stock. Today, about 11% of the U.S. market capitalization is made up of dual-class stocks, including many tech stocks that became public in the past two years.
Theoretically, supervoting shares enable holders to minimize or ignore short-term pressures from the market, activist investors, and others while protecting their ability to execute against their longer-term visions for the company. In reality, however, such shares are a blunt and imprecise tool, and their existence creates an arbitrary division between the haves and have-nots when it comes to corporate stakes and governance. Often, founders, current management, and venture capitalists receive higher-voting shares at the time of a company’s initial public offering, meaning that post-IPO buyers have less say in governance, fairly or not.
But what if there were a more precise way to align the interests of management and shareholders, and enable incentives for long-term decision making without disenfranchising an entire class of (non-insider) holders? Enter tenure-based voting, which would enable any investor — whether founder or institution or individual — to accrue more voting control the longer they hold a stock.
Tenure-based voting would allow all shareholders to have an equal opportunity to earn a greater say in a company’s governance. All longer-term investors — with the definition of “longer term” agreed upon by the company and its shareholders — would earn more rights to weigh in on strategy and management, while shorter-term investors would simply vote with their feet by selling their shares if they aren’t aligned with that strategy. In adopting a tenure-based voting system, a company and its shareholders would need to determine the time periods associated with higher-vote stock. For example, all shares could start with one vote per share as of the acquisition date of the shares, and after, say, a two-year hold period, accrete to 1.5 votes per share, with perhaps additional votes per share for each additional holding period. If an investor were to sell her shares, the new holder of the shares would start at one vote/one share and begin a new holding period. The rules could be tailored to achieve whatever goals the shareholders have in mind, probably requiring a majority of shareholders to approve the initial plan (or any substantive modifications).
Ultimately, with tenure voting, everyone is aligned: Management teams that sell their shares in the market would have less control over time, and institutional investors who hold their shares for longer periods would accrue more voting power. This approach is far more democratic than the dual-class structures some institutional investors have opposed.
The idea of tenure voting isn’t new. With a step-up in hostile takeover activity in the 1980s, corporations began looking to disparate voting mechanisms — such as dual-class structures and tenure voting — to thwart unwanted advances. But the Securities and Exchange Commission, concerned about efforts to disenfranchise any segment of shareholders, tried to legislate away both in 1988 by enacting Rule 19c-4, which prohibited stock exchanges from listing or trading shares of companies that took any action to reduce existing shareholder voting rights.
Even when the courts overturned the rule two years later, the SEC lobbied the exchanges to amend their own listing standards to prohibit disparate voting standards. Interestingly, dual class, when adopted pre-IPO, has survived the exchange rules, but the rules specifically outlawed “time-phased voting plans,” which many have interpreted as a prohibition against tenure-based voting.
All of these moves have largely kept tenure-based voting out of the public markets. But the story isn’t over: The SEC recently approved the application for an alternative listing exchange, the Long-Term Stock Exchange (LTSE) — the only exchange headquartered in California, a driver of much technology innovation and economic growth. [We are investors in LTSE.] Among other features, the LTSE listing rules enable tenure-based voting for all shareholders, so we are about to see the utility of this approach play out in the markets.
There still are plenty of questions about tenure-based voting, including whether systems exist to accurately track holding periods for different shareholders. But this is the type of experimentation we need, to figure out whether and how tenure-based voting works. The greater the variety of governance models and experiments, the greater our ability to protect the long-term leadership, integrity, and vitality of the U.S. capital markets.
This article first appeared in Barron’s.
