9:35

Separation of Voting Rights from Cash Flow

Summary: 

One person, one vote+ is an unusual rule for business. Here we describe it in terms of a dual class capitalization (Class A, Class B, etc.) as found in many traditional corporations.

You can’t fix stupid White, Ron (2006). I had the right to remain silent – but I didn’t have the ability.

If investors are not going to vote even when it’s in their own best interest (or they vote in ignorance) then they deserve what they get. However, we don’t visit the sins of the father upon the children. Our judiciary protects future voters from today’s voter apathy.

 

 

Dual Class Capitalization

One person, one vote+. We explore implications of this voting rule from the perspective of dual class capitalization structures, as found in many modern corporations. Typically this involves a Class A shares with full voting rights and Class B shares with inferior or no voting rights. When both classes share equally in cash flows from the firm, then Class A trades at a 5% to 35% premium over Class B. The vote has value per se, but many other factors influence its value (e.g., countries with strong governmental protections of shareholder rights, percentage of Class A shares already owned by insiders).

Dual structures arise because insiders (e.g., management and institutional investors) want their votes to count more. They want it so badly they are known to take out (extremely) large loans, purchase Class A shares, vote the shares, and then after the vote sell the shares and settle the loans.1 This achieves overwhelming voting power with minimal financial risk. Why is it rare to see large share prices (e.g., tens of thousands of U.S. dollars per share)? Because individuals purchasing these shares would tend to vote these shares. Insiders prefer low share prices to let inattentive low share price investors waste their votes. There are dozens of other ‘tricks’ of this genre at the disposal of insiders. They are a consequence of having a one share, one vote rule. Insiders get their way, subtly shifting wealth from unsophisticated investors to themselves.

Consider an extreme version of dual structure where Class A gets all the votes and Class B gets all the cash flows. Why would any investor buy Class B when Class A can come along and take away all the cash flows in the next vote? Because it’s unlikely Class A would act precipitously. And, it’s likely Class A shareholders also are Class B shareholders. Instead there will be a gradual, barely perceptible erosion in wealth from Class B toward Class A; or it could happen suddenly following a disruption of business, such as during an acquisition or in an overall market collapse. Class A shareholders appropriate much but not all the wealth and Class B shareholders end up content but not thrilled. Owning only Class B shares seems risky, but it is quite common.2

One Person, One Vote

One person, one vote. For the funding agency+, Class A shares have the same cash flow rights as Class B shares, in addition to exclusive voting rights. We allow investors holding $100K in Class B shares (illustratively) to purchase one and only one Class A share. The vote is priced low but is not trivial. As an illustration Class A carries a $500 premium over Class B shares (in 2011 U.S. dollars). Here are the rest of the rules:

  • Shareholders can only purchase one, non-transferable Class A share
  • Shareholders must purchase the right to vote annually (i.e., by purchasing a Class A share), should they so desire. The right to vote expires after a year (i.e., Class A shares automatically convert to Class B).
  • Class A shareholders must have and must maintain skin-in-the-game (e.g., $100K in Class B shares)
  • We will not bribe or cajole shareholders into purchasing Class A shares; there are no benefits beyond the right to have your vote count.

Class A shareholders signal to the firm they are interested in the vote per se, a sort of self-interested love of institution. 3 Ideally the Class A purchase period coincides with the announcement of an upcoming slate of candidates – propositions, so purchasers know for what it is they are paying to vote, at least in the one upcoming ballot.

Protections

We use the judiciary to sort out any shortcomings from the use of the one person, one vote rule. For example, Class A shareholders often represent old money and will be tempted to shortchange programs benefiting new money. Or, agency management+ will not have the votes to stave off intervention (i.e., meddling) by Class A shareholders. Or, agency management will have a difficult time securing their much-maligned, but often worthwhile perquisites (e.g., the corporate jet). The judiciary steps in to right these and other shortcomings through its power to construct the vote.

There will always be inattentive Class A shareholders who will waste their votes. This redounds to the benefit of insiders (agency management and institutional investors) who never forget to vote. We put in place mechanisms to attract investors to the polls:

  • Special Interest Groups, which get their members to the polls by placing issues or candidates of their concern on the ballot
  • Literacy Tests attract investors to the polls by paying voters for their completion (both 'Class A' and Class B-only shareholders)
  • Scandal Sheet+ articles often gin up interest for upcoming votes.

Agency management or investor cabals can still appropriate wealth by taking advantage of apathetic Class A shareholders. Despite it being their own fault, bad outcomes can still be damaging to the confidence of voters who let it happen. We put in place mechanisms to attract voters to the polls, but we’re not big brother.

The purchased-vote rule (i.e., purchase of 'Class A' shares as a right to vote) gives early warning as to the level of interest in an upcoming slate of candidates and issues. This gives the judiciary time to minimize damage from looming voter apathy. Next-generation voters are protected through the use of voting constructs+ (e.g., negotiating the wording of propositions so damage is confined to the current generation of apathetic voters). Current generation voters are left to sort out on their own whether or not they want to let others take away their rights and money.

A Two-Investor Thought Experiment

Assume there are two investors, one investing $1 million and the other $1. Do they each deserve one vote? It’s clear the millionaire would insist on rules giving him or her overwhelming voting power. What if the other invested $100,000. Should the millionaire get ten times the vote? Investing $100,000 is more than enough evidence of skin-in-the-game for investor #2.

Is the millionare smarter? Not likely. The millionaire’s dollars often come from investing in old industry, and we need voters smart about new industries (e.g., Phase 1 industries+).

Do millionaires claim they need ten times the protection? “Ten hundred-thousandaires will gang up on me and take away my million!” Protections come from the judiciary. A ‘gang’ of investors must first prevail at the polls and the judiciary holds quite powerful controls over this venue.

With the protections of our judiciary there are no non-selfish reasons for one investor having a greater vote than the other,4 once investors have sufficient skin-in-the-game. Success redounds to the community and to each according to his or her financial investment into the community. This has nothing to do with voting power. We will not allow ourselves to be held hostage+ by any one or few major investors who insist they deserve a greater say in running the agency by virtue of their wealth.

For this reason the funding agency prefers retail investors, who are less likely to play the better-than-thou mind games of the super rich. Every investor, rich or upper middle class, comes to our fund essentially as a babe. We’re that new. We place a very high emphasis on investor education and participation, to grow as many issue-literate voters as we can, and wealth does not make old dogs any better at learning new tricks.5

Closing Commentary

Democracy (one person, one vote) is often less efficient than tyranny (as enabled by one share, one vote). Benevolent tyrants can move quickly, without need for lengthy consultations. Hence their ubiquity in today’s corporate world. Tyranny is often not good for enterprises to be sustained over many generations. Tyranny is often not good for enterprises pursuing effectiveness over efficiency. We seek the best from both these polities. The judiciary constructs votes to keep the demos at bay. We allow agency management great flexibility and freedom from the tyranny of the demos. Anything management needs to further the wealth-building mission of the agency is placed at their disposal (e.g., corporate jets). The demos is allowed its voice, though, when agency management acts tyrannical for its own sake. Our voting structure is designed to sense gathering storms of investor discontent. The demos, for all its purported stupidity, will be paid homage.


Editor's Picks for September, 2011

  • 1. The timing of our Open Season+ vis-à-vis major votes becomes important.
  • 2. It’s the free-rider problem in economics, where investors buy less expensive Class B shares with the hope others will look out for their interests.
  • 3. All holders of Class B shares are permitted to vote, but only Class A votes count. Non-holders of Class A can vote for practice or informational purposes. This gives important information to the judiciary (which watches over the voting process) about the level of unmet demand for voting within the overall Class B population. We value (and pay for) literacy tests from practice voters.
  • 4. Private benefits include prestige, consumption of perquisites, excessive salaries, or the sale of assets below market value to another firm of interest to the investor.
  • 5. The literacy test can give educated investors (e.g., veterans) in our funding agency a more powerful vote over novice investors. The judiciary will often skew voting results toward the will of the informed vote.
Further Reading
Reba Tull
Offline
Joined: 03/30/2011
Millionaires will not be convinced

The key distinction is found in the phrase "can only purchase one, non-transferable Class A share". This will grate on agency management+ who will feel they deserve a greater voice given their much greater expertise and responsibilities. As discussed elsewhere perhaps it is better to show greater flexibility in the definition of ‘vote’ – giving management greater voice for issues in which they have unequivocal and unique advantages. Class C shares anyone?

Joe-investor will have little incentive to acquire the information needed to effectively monitor funding agency+ management. Managers will enjoy considerable latitude in running the firm, which they can abuse to pursue their own interest (e.g., using the firm's funds to finance the election of their preferred national government candidates). One mechanism for mitigating this outcome is to allow a larger vote for a few large shareholders. That is to say, we should consider at least a partial deviation from one person, one vote+.