The Long Term Stock Exchange

A new stock exchange is being started up and backed by Silicon Valley.  It gives more voting power to shareholders that hold their shares longer.  I wonder if this is solving a real problem or not?  IEX started and executes trades differently.  We will see if they are successful or not.

Personally, I am for as many companies going public as possible.  It’s good for companies and good for America.

Most Americans do not vote their proxies at annual meetings.  Less than 50% of outstanding shares held by retail investors are actually voted, according to Broadridge Financial Solutions, a provider of investor communications and proxy processing services.  For the fiscal year 2013, which ended June 30, 30 percent of shares held by retail investors were voted, but just 13 percent of retail shareholders cast a vote, according to research by Broadridge.

If I hold my shares and put my dividends in a dividend reinvestment program, I already get more votes.  If I want more votes, I can use my capital and buy more shares.  American tax law incentivizes holding shares for more than one year.  HFT traders pay top tier income tax rates on any SEC-regulated trade they execute.  In commodities, they pay a 60/40 blended rate between the highest tax bracket and capital gains rates.

One downside to tenure voting would be a group of shareholders gets voting control over the company that is then able to push the company into directions or actions that are detrimental to the long-term profitability of the firm.  For example, we had seen all kinds of crazy corporate resolutions make corporate ballots from activist shareholders. They normally lose.  If a serious proposal gets 10-20% of a shareholder vote, generally management acts.

My friend Neal Wolkoff doesn’t like the idea. He was CEO of the AMEX.  He thinks that it will depress stock values because tenured voting will limit the market forces on management.   I also wonder about secondary derivative markets.  Will you want to trade options on a listed stock with tenured voting?  Would it change the calculation around underlying volatility?  Can market forces put enough pressure on management to change and adjust?

A short example.  At CME in the mid-1990’s, we were privately held, membership run and non-profit.  A group of us wanted to change and spend money on technology to change the strategic course of the exchange.  We also wanted to go public.  There was a large entrenched group who controlled the Board of Directors that didn’t want to change because their businesses would likely go under in an electronic environment.  If CME had tenured voting, I doubt if it would be in business today.  The CME did have class voting, which meant if you could persuade one class you could win.

The problem is many Silicon Valley firms are staying private longer.  I don’t like the trend because it shuts out a lot of the American public from buying shares in companies that have high growth and are revolutionizing the world economy.  Why are they doing it?  It’s not voting rights. Plenty of public companies from Facebook to Snap to Ford have figured out how to retain control in few hands while being public.  I know a lot of people bitch about quarterly earnings, but as long as a company gives long-term guidance who cares about a bad quarter?  It hasn’t seemed to hurt companies like Amazon which pays no dividend and doesn’t turn a GAAP accounting profit.

We can point to a few reasons why companies are staying private longer.  Sure, there are the regulations.  Those are very costly and should be looked at.  The SEC and the federal government should make it as easy to go public as possible while at the same time protecting the investor from fraud.  Controlling corporate governance may play a role.  But who is kidding who?  How much input do shareholders have over corporate governance today?  That seems like a minor point especially given shareholder participation in proxy balloting.

What about the cost of capital?  One of the concepts you learn about in an MBA finance is WAAC.  It’s the weighted actual cost of capital and it drives corporate financial decision making. Here is the formula:

I have never seen a longer period of time in my life, or in modern business history where private capital costs have remained so low. Fed interest rates are still closer to zero than they are their long-time norm of 4%. The cost to raise and the cost of private equity or venture capital is extremely low compared to the cost of raising from public markets.  Not only that, competition among private firms have driven higher prices to enter deals.  We have seen deal valuations rise consistently over the past ten years, especially in later stages of financing.

I think that having competition among exchanges is a good thing.  It takes far too long to go through the regulatory process to create an exchange.  That process also gives a “heads up” to existing exchanges about potential competition.  However, I am not convinced that this effort is solving a real problem that it is in the marketplace.  I could be persuaded otherwise, but I really think this is a cost of capital problem not a voter right problem.

  • Aaron

    A stock exchange that allows more control to shareholders will not attract companies like GOOGL Brin and Page have 3 classes of stock for control.
    Zuckerburg just dropped an idea to do that himself.