The UK hosts one of the world’s deepest public capital markets. Businesses from across the world list on the London Stock Exchange’s Main Market and its reputation among institutional investors is top-notch. But policymakers are concerned that the market is no longer a draw for some of the world’s most innovative businesses. It’s part of a broader concern that while many great tech businesses are started in the UK, many sell up to US tech giants. Autonomy (acquired by HP in 2017) and DeepMind (acquired by Google in 2014) are probably the two most famous cases.
Rishi Sunak aims to change that. This week, he announced a taskforce to look into reforms to make the UK’s listing regime more attractive to tech. The biggest question for the taskforce to tackle is whether or not to allow dual class share listings.
In recent years, when tech companies have gone public, their founders have been reluctant to give up control. They’re afraid their long-term vision will be bogged down by short-termist stock markets preoccupied with quarterly returns. To access the benefits of public markets without relinquishing control, tech companies have employed a dual class share structure. Take Facebook: everyday shareholders own Class A shares worth 1 vote per share, by contrast Class B shares controlled by Mark Zuckerberg and other Facebook insiders are worth 10 votes. As a result, Zuckerberg controls 60% of the voting shares at Facebook. The situation is similar at Google. Tesla is slightly different, but has strict super-majority rules that ensure that any proposal opposed by Elon Musk must be backed by 89.5% of outside shareholders.
Another way founder-led tech businesses can retain control is by only floating a small percentage of their shares when they IPO. For instance, when LinkedIn floated in 2011 they only released 9.4% of their shares. On this, Google was a trendsetter having only issued 8.3% of its shares when it floated in 2004.
Both of the above arrangements would bar a business from a Premium Listing on the London Stock Exchange’s Main Markets, which means the company could not join any FTSE indices.
Should this change? On the one hand, the London Stock Exchange’s shareholder friendly rules are a hit with institutional investors. Without strong protections, there is a risk that investors would be unable to protect their interests when they conflict with management. George Dallas of the International Corporate Governance Network, who opposes the move, alleges that allowing dual class shares would “erode accountability to management and have the effect of entrenching managers and controlling owners.” It certainly isn’t hard to find examples in the 1970s where management took advantage of shareholders, investing in vanity projects and empire building. Whatever you think of Michael Milken and his ilk, his opponents such as RJR Nabisco’s Ross Johnson were hardly deserving of sympathy.
On the other hand, founders are attracted to dual-class share listings and small floats because they allow them to retain control and execute their long-term vision. They fear that a narrow focus on short-term quarterly results can lead to under-investment in research and development and long-run irrelevance.
Fears around stock market short-termism may be overblown, but they are clearly taken seriously by tech founders. With VC markets allowing businesses to stay private for longer, there is a clear need for greater flexibility in public markets. In the US, Lean Startup author Eric Ries has responded by founding the Long-Term Stock Exchange and received backing from major VCs such as Marc Andressen. It’s designed to allow Silicon Valley businesses to access the benefits of public markets, such as allowing employees to easily sell their shares while prioritising patient capital.
There is a broader political case for making it easier for innovative founder-led businesses to list. We risk undermining a culture of shareholder capitalism if ordinary investors are shut out from the fastest growing parts of the economy.
On dual-class shares, the UK is an outlier. The US has allowed the arrangements for a while and recently Singapore and Hong Kong have liberalised rules allowing founders to have greater control in certain circumstances.
Some may argue that reform is unnecessary. After all, Deliveroo and Darktrace are both set to IPO on the London Stock Exchange. However, some businesses are clearly frustrated. The Hut Group’s recent £5.4bn IPO did not achieve a premium listing and as a result, investors in FTSE indices will miss out.
With existing rules deterring tech businesses from listing in London, the burden of proof should be on opponents of reform to prove harm. Yet, a range of studies suggest that relaxing the UK’s rules on premium listings carry little risk to investors.
One study in the Stanford Law Review, which looked at 34 years of data of board staggering and destaggerings, found that staggered boards are “associated with a statistically and economically significant increase in firm value”. Stronger boards, which give shareholders less direct influence, deliver better returns. It is worth noting that past cross-sectional research found the opposite, but unlike this study, that research did not control for the reasons why boards staggered or destaggered.
The situation is analogous to dual class share ownership. While staggered boards reduce the ability of shareholders to kick out management when quarterly results disappoint, they also give management more flexibility to focus on the long term.
Additional research casts doubt on the merit of the London Stock Exchange’s 25% minimum free float requirement for premium listings. A study to be published in the Journal of Banking and Finance finds that companies that float less than 20% of their shares outperform the market over the long term. The status quo is in some ways, the worst of both worlds. The researchers find that while small floats do best, big floats also perform well. It’s the inbetweeners selling between 20% and 40% that perform worst.
This is not to advocate a free-for-all, however. We may be better off charting a middle course as Hong Kong and Singapore have. As the SEC commissioner Robert Jackson Jr notes: “Nearly half of the companies who went public with dual-class over the last 15 years gave corporate insiders outsized voting rights in perpetuity. Those companies are asking shareholders to trust management’s business judgment—not just for five years, or 10 years, or even 50 years. Forever.”
He analysed 157 dual-class IPOs form the past 15 years and found that businesses that had sunset provisions on their dual-class shares performed better over the medium to long term.
There’s a strong case for reform and liberalisation. The taskforce should update outdated rules on dual-class shares and minimum float requirements, but consider sunset provisions to protect investors. Doing so would preserve London’s position as a world-leading financial centre and allow more retail investors to gain a stake in Britain’s most innovative businesses.