Silicon Valley eyes plan to reward long term shareholders

This is not an obvious time for Silicon Valley to complain that some of its best ideas are being ignored by Wall Street.

Not since the dotcom bubble two decades ago have lossmaking tech companies found such an easy path to the public markets. Uber and Lyft (combined cash burn over the past three years: $10bn) have been the most visible examples this year, but they are far from alone.

Jay Ritter, a researcher at the University of Florida, calculated that 84 per cent of tech companies doing an IPO in 2018 were lossmaking the year before, up from only 29 per cent a decade ago and only just below the dotcom high.

Of course, the market’s current hunger for growth over profits is not the norm. Over the long term, according to AllianceBernstein, the stocks of companies with high sales growth underperform the S&P 500 by an annualised 2.9 per cent, while those that generate high profitability (measured by return on assets) outperform by almost as much.

So does that mean Wall Street is rational, voting for positive cash flow over corporate empire-building? Or that it tends to revert towards a short-sighted mean, picking companies that can deliver profits now rather than build strong market positions for the future?

Some Silicon Valley insiders strongly believe the latter. Their answer — called the Long Term Stock Exchange — was formally approved by the SEC last month, and has just published its first set of proposed listing rules.

As the name suggests, the exchange hopes to establish a new contract between investors and companies that encourages the pursuit of long-term value creation — measured in “years, decades, and generations” — over short-term profits. 

The brainchild of Eric Ries, author of The Lean Startup, it has the backing of venture capitalists like Founders Fund and Andreessen Horowitz. They argue that Wall Street short-termism has discouraged many tech companies from going public.

The rules published this week are a first stab at establishing the general principles that companies would sign up to when listing on the exchange. That makes them necessarily bland. What company wouldn’t claim to consider all stakeholders in its decision-making, or invest in its staff for the long term?

But more detailed listing rules will follow. The most controversial proposal is to reward long-term shareholders with more voting power: the longer shares are held, the greater the voting rights that attach to them.

To critics, this sounds like a new twist on the idea of concentrating voting rights to subvert the normal market for corporate control. Silicon Valley’s current way of doing this — using special classes of founder stock with supervoting rights — has already led to a stand-off with investor rights groups.

Letting more votes accrue over time presents a paradox for investors with a true long-term perspective. They would be rewarded for their patience with higher voting rights. But when the time finally came to sell, the rights attached to the shares would reset, meaning that the long-term investor wouldn’t be able to capture some of the value their patience has helped create.

It would also, by definition, concentrate power in the hands of founders and early investors who are in the driving seat at the time of a company’s IPO.

Not surprisingly, some corporate governance experts are loath to back anything that detracts from the principle of one share, one vote. The Council of Institutional Investors complains that concentrating power in the hands of a small number of big institutional investors — or governments that hold stock — will not necessarily lead to better decision making. It points to the example of France, where government ownership introduces political considerations that are not with the interests of other investors.

Creating a disconnect between ownership and control may have other, unintended consequences, according to the Council. For instance, it would put all new investors in a company at a disadvantage — including those who want to invest for genuinely long term reasons. And investors’ time horizons change: just because someone has been a holder for a number of years doesn’t mean they are still committed for the long term.

Despite these drawbacks, it is hard to argue with the idea of bringing more competition to listings rules. If enough issuers and investors truly feel that the current arrangements hurt their interests, then it makes sense to offer alternatives.

It will take explicit backing from a large slice of big investors to give companies the confidence to adopt new listing rules like these. That seems a long shot — but it is still worth debating.

richard.waters@ft.com