All Shares Are Not Created Equal
For nervous founders and insecure managers of public ompanies, the best defense against a hostile takeover is to outvote the pillaging scoundrels. Thus it is that 39 New York Stock Exchange (NYSE) companies have sought and received stockholder approval to issue shares with unequal voting rights and are awaiting NYSE permission to recapitalize. By recapitalizing -- altering the nature of the equity instruments that underlie a business structure -- insiders can assure themselves of continued control undisturbed by profit-hungry predators, dissident stockholder, or whatever other intimidation might someday come down the pike. The recent spate of recapitalization has involved creating a second class of common stock that bears drastically less electoral clout than the original. Insiders, of course, retain the high-vote shares.
The spate is not a surge, to be sure, but it constitutes enough unrest to perplex the NYSE, an unswerving if unexpected champion of the rights of Wall Street's little guy. For more than 60 years, the Exchange has clung to a one-share, one-vote ideal, but in July 1986, the Big Board jettisoned its position and "reluctantly" (at least, so said chairman and chief executive officer John Phelan) sought Securities and Exchange Commission approval to trade corporate stock with however many votes management needed.
Since the NYSE's chief competitors, NASDQ and the Amex, have listed such multi-class equities for a number of years, the decision, expected this spring, is apt to be favorable. If that happens, businesses recapitalizing on the NYSE will attempt to persuade their stockholders to accept second-class citizenship by dressing up the inferior shares with such nominal incentives as extra dividends, superior standing versus the higher-voting common in the event of liquidation, or the right to elect a minority portion of the board of directors.
Fat-cat companies with NYSE visibility aren't the only ones taking evasive steps. In 1985, slimly capitalized (735,651 shares) Keithley Instruments was among several low-profile corporations in the over-the-counter market amending their articles of incorporation to provide for multiple-class common. Keithley's method was to issue a Class B common that, in what is by now a typical ratio, outvoted the old common 10 to one. Keithley stock-owners were given a 45-day window in which to convert their old common holdings into the new, higher-voting Class B, which, all else being equal, they would.
All else was not equal, however. As a lure to convince them not to convert, part of the stipulation was that the old common would get at least 25% more in cash dividends. Stockholders were diligently advised by mail that if no shareholder but founder Joseph F. Keithley were to make the exchange, his 51.7% voting representation would increase to "approximately 91%." And that was not far off: when all the conversions were in, the then-69-year-old founder wound up owning more than 80% of the votes. The low-vote common, listed on NASDAQ, can be used for stock options, for fresh financing, or in merger negotiations, without significantly diluting the family's eternal hold on control.
Maybe Keithley Instruments wasn't the immediate apple of some lusting raider's eye. But, asked chief financial officer Ron Rebner, why wait? "Acquisitions are causing problems in other companies, and we had a good thing going. Now, we don't need to worry about someone coming along and buying us out. I wouldn't want to be the guy sitting here when someday they have to worry about control of the corporation." On the other hand, the seat might be equally uncomfortable if family control fell to Keithley kin who disdained interest in the soundness of the company's operations.
Along with staggered boards, super-majorities, fair-price provisions, and a few other antitakeover dodges, corporate caste systems have come into stark prominence in this dark day of the raider. But undemocratic equity structures are hardly novel. In 1975, the founder of Wang Laboratories Inc. boldly delisted his company from the restrictive NYSE and went on the Amex, where he was free to float lower-vote common to raise working capital. Wang's maneuver is a fine example of how to keep control and ward off unwanted Wall Street suitors, yet have financing flexibility. Unfortunately, the company's downturn is an equally fine example of what might happen when outside stockholders are rendered powerless to challenge entrenched management: on the heels of a $30-million quarterly loss, Wang was forced to restructure this January.
Striking the proper imbalance is mostly a matter of apportioning a small fraction of a vote to the outs for every vote the ins retain. But a few variations on that theme have emerged. The J.M. Smucker Co., a venerable, vulnerable, and largely family-held NYSE listee, for example, has a restricted-vote common that rewards loyal stockholders. Only those holding the stock for four years earn full voting power -- an effective antitakeover measure, as no marauder since Genghis Khan has had the patience to wait that long.
A corporation can have even more fun with dual common before it goes public, by writing it into the charter document. One ploy newly public companies have been adopting is to stipulate that votes be reduced in any block of stock representing more than a small percentage of the total shares outstanding. Thus a party accumulating a large position -- over 20%, say -- ipso facto suffers severe voting dilution. (Of course, the charter document exempts present big-block shareholders.) Each situation is different, and emerging corporations can devise just about any deal they want, declares Thomas F. McKee of Calfee, Halter & Griswold, a Cleveland law firm with a specialty in multi-class entities. Indeed, a few angst-ridden entrepreneurs have started from scratch with fail-safe voting ratios as low as one to 100 -- or even, as in the case of The Washington Post Co. in 1971, zero to one. But, the lawyers caution, underwriters don't like to see terms that are too ridiculous.
So far, underwriters are going along with the trend -- if trend it can be called. More than 50 initial public offerings have come out with multiple classes of common in the past three years, and of those, some did it more out of necessity than conceit. A broadcasting license, for example, can be removed by the Federal Communications Commission if business control of the station changes hands; pocketbooks loosen up when they can be assured the investment won't inadvertently become worthless by outside interests taking over. Even so, with the NYSE hopefuls and the cachet of sch names as Dow Jones & Co. and Hershey Foods Corp. already in the recapitalizing camp, dual-class popularity is bound to pick up.
Indeed, there's no reason why all private corporations planning to go public shouldn't capitalize with two classes of common -- one retained by the owners, the other marketed to investors. In 1985, OshKosh B'Gosh Inc., a clothing manufactuer in Wisconsin, eased nicely into the public arena by first recapitalizing one share of common into 15 Class A nonvoting shares and 5 voting Class B. A group of major stockholders then sold blocks of their Class A holdings through an underwriter, and -- voila -- the company was public. Even though they sold a lot of stock, insiders' votes remained undiluted. The Class A buyers (b'golly, OshKosh assigned "A" to the public stock "because it sounded better") were rewarded with a 15% bonus in cash dividends and the opportunity to elect one-quarter of the board. The IPO came out at $25 and by the end of the first day had been bid up to $30. "What that shows," concludes corporate secretary Steven Duback, "is that the lack of meaningful voting rights doesn't mean much." Perhaps not at the moment, among the genre's slim IPO pickings. But in the rush that is sure to come if the SEC grants the NYSE request, multi-class new issues may find the going nettlesome.
One current bramble is the hodgepodge of provisions -- called blue-sky laws -- by which individual states judge and regulate the fairness of securities offerings made to the general public. Even if the SEC passes on the new issue, an individual state can prevent it from being bought or sold there. A good number of states, including such financial hot spots as Texas and Massachusetts, ban unequal voting on IPOs outright. Others require minimum board representation, a ceiling on the voting ratio, or prominent statements in the prospectus notifying retail buyers that they'll be receiving irregular goods. In the aggregate, blue-sky laws can take away a considerable number of would-be customers.
Unequal-voting IPOs also may find they will have to forfeit the customary premiums associated with bull markets in new issues. To float inferior securities successfully, a concession in price might have to be granted, since savvy investors will be unwilling to sign up for voting impotence. Or to miss the chance of a quick killing when takeover rumors send the stock soaring higher than sedentary executives could. While it may be tempting to write a clause in a company's charter document allowing an inferior-vote class of common at a future date when it's needed, don't: underwriters want to know exactly what they are buying; they wouldn't like it if the second class came out down the road. "Either do it up front," say Calfee, Halter & Griswold, "or leave it out of the charter document altogether and get a vote of all the shareholders later."
For today's light offerings, underwriters steer around irritating blue-sky laws and recalcitrant investors. But Paul H. Carleton, senior vice-president of corporate finance of NYSE member McDonald & Company Securities Inc., predicts that indiscriminate adoption of multi-class capitalization by emerging corporations could eventually be self-defeating. "When too many think they can get away with it," Carleton frets, "the market will exact its penalty." And it could be severe, as under any regime where the only recourse left to disenfranchised citizens is revolt.