Investor advocates are turning the spotlight on the corporate governance practices of newly public companies that they regard as hostile to shareholder interests. In connection with their IPOs, most companies adopt customary defensive measures to protect themselves from activist investors, who might otherwise take advantage of their typically smaller market capitalizations to try to seize control of the company. These measures often include a classified board of directors, whose terms are staggered over three years. With a classified board, shareholders can elect only one-third of the board in any given year and, as a result, it would take more than a year for an activist to elect a majority of the board.
Less often but with increasing frequency in recent years, some notable companies like Square, Google and Facebook have adopted dual-class capital structures that give some pre-IPO stockholders (usually founders) multiple votes per share. These super-voting shares allow early investors to maintain majority control of the company well into the future and allow that control to continue even when their holdings constitute only a minority stake. Unlike other defensive measures, this dual-class capital structure generally must be implemented before the IPO because the listing rules of the major securities exchanges prohibit its use.
In its recently issued Proxy Voting Guidelines for meetings to be held on or after February 1, 2017, Institutional Shareholder Services indicated that it would generally recommend that shareholders not vote for the re-election of some or all directors of companies that implement either classified boards or dual-class capital structures with unequal voting rights. In making its assessment, ISS said it would consider mitigating factors, such as built-in sunset provisions or reasonable thresholds for amending the defensive measures. ISS indicated that its adverse recommendation might continue until the offending provisions are removed.
While we do not expect that IPO companies will widely abandon traditional defensive measures, ISS’s position reflects continued increased attention to governance practices immediately after the IPO. Both IPO companies and existing public companies that still have these mechanisms should anticipate possible adverse reactions from investors and make a plan to address investors’ concerns.