Assault on Principle of One Share, One Vote Stirs Growing Concern

THE CHALLENGE TO SHAREHOLDER RIGHTS A vast array of restrictions on shareholder rights is producing perhaps the greatest shift in control of American business since the Great Depression. Executives say the restrictions are needed to fend off destructive takeovers. Critics say they leave shareholders powerless and management unassailable. This special report examines the controversy and the consequences, beginning with a story on Page 1, Part I.

Like the corporations whose shares cross its trading floor by the hundreds of millions every working day, the New York Stock Exchange is a business. Lately its chairman, John Phelan, has had to face the question of whether competition is forcing the Big Board to give up its tradition of quality control.

As early as next month, the NYSE will ask federal regulators to approve the most significant change in its standards for listed securities since those standards came into being in 1926. The request may become the focus of the most important public debate in half a century over the issue of shareholder rights.

At issue is a NYSE plan to end its 1926-vintage prohibition on the issuance of common stock with unequal voting rights. That might sound less than earthshaking, given that the turnout on corporate votes often falls short of that in off-year primary elections.

But the principle of one share, one vote has become a rallying cry for the growing number of shareholder-rights activists. When the Council of Institutional Investors, a confederacy of government pension plan sponsors organized by California state Treasurer Jesse Unruh, convened in March to write a “shareholders’ bill of rights,” the preservation of one share, one vote was Article I.

Institutional investors increasingly sense that corporate managements are creating multiple-class stock issues with unequal votes to curtail their authority as stockholders over directors and executives.

In the last two years, scores of corporations have implemented, proposed or contemplated dilutions of the one share, one vote rule. Generally their goal is to discourage hostile takeovers by concentrating control in the hands of small groups of insiders aligned with management.

Of companies now listed on the NYSE, 17 already have plans or proposals to create unequal voting classes. Some professionals estimate that as many as 200 of the nation’s largest companies may join this line if the NYSE changes its listing standards.

Some people consider this trend to be an adulteration of the common share’s traditional status in a corporation’s capital structure.

Although stockholders get a share of corporate profits through the payment of dividends, they have to stand in line for that money behind all other creditors and investors, including lenders, bondholders and the owners of preferred stock.

To make their junior status more palatable, common stockholders have traditionally been given the status of owners through the voice in corporate affairs that they can exercise by voting to elect directors and on other issues.

With unequal voting shares, common stockholders will be left with a diminished capacity to safeguard their more risky investment.

“If you let me create the world, I’d create one class of common stock,” NYSE Chairman Phelan said in a recent interview. But the exchange now finds itself in a world not of its own making.

With their less stringent standards, the American Stock Exchange and the over-the-counter market run by the National Assn. of Securities Dealers have been able to attract several companies tossed off the NYSE for violating its dual-class prohibition.

Suspended Delistings

Faced with the prospect of ejecting, or “delisting,” such important companies as General Motors and Dow Jones & Co. for creating stock with unequal voting rights, the Big Board in 1984 suspended such delisting proceedings and asked a blue-ribbon committee to review its rules.

Under former Securities and Exchange Commissioner A. A. Sommer Jr., the panel recommended that companies be permitted to issue common stock with unequal voting rights as long as the change was approved by two-thirds of existing stockholders and by a majority of outside directors, and provided that one class of stock has no more than 10 times the voting power of another class. The proposal is the model for the NYSE’s submission to the SEC.

But more than just the nature of common stocks traded on the NYSE would change if the SEC gives its approval. At the core of the exchange’s proposal is its contention that it can no longer afford to be, on the SEC’s behalf, the sternest policeman of the stock market.

“Our listed companies are saying, ‘you should have been in the (regulation) business in 1900, but you shouldn’t be now,’ ” Phelan said.

In the 1920s, when the one share, one vote rule entered the exchange’s rule book, it had a de facto monopoly over stock trading. “There was no place else a first-class company could go to be traded,” said Sommer. “No company was going to withdraw from the New York Stock Exchange.”

It has scarcely escaped the Big Board’s notice that the trading technology of the over-the-counter market has so improved that companies threatened with delisting now greet the news with equanimity.

Works Just as Well

“The over-the-counter market for a company as actively traded as ours is just as good as the Big Board,” said Lee Anderson, investor relations officer for American Family Corp., a cancer-insurance company that established a dual-class common stock in 1985.

(The system grants 10 votes to each share held four years or longer, and one vote for all others.)

The hollowness of the delisting threat was underscored when GM established a second class of stock in 1984 and a third last year. No one seriously suggested that the exchange would cut loose one of its biggest listed companies over the issue.

The new classes, known as General Motors E and General Motors H, gave holders a share in the earnings of two new GM subsidiaries, Electronic Data Systems and Hughes Aircraft.

GM said they are designed to encourage entrepreneurial management at the newly acquired units by giving employee-stockholders a direct interest in the subsidiaries’ earnings.

That the SEC’s deliberations will come under a political spotlight is certain, as two members of Congress, Sen. Alphonse D’Amato (R-N.Y.) and Rep. John Dingell (D-Mich.), reacted to the Sommer recommendations last year by immediately filing bills mandating preservation of the NYSE’s listing standards.

(The immediate crisis having passed, the bills are currently tabled.)

Sommer himself is not blind to the quandary that his proposals create for the SEC. “It’s unconscionable for them to tell the exchange it’s got to keep its rules while they let the other exchanges go,” he said. But if the NYSE rules change, Sommer adds, it will open the door to a “race to the bottom” in standards.

Rejected ‘Sunset’ Plan

Sommer said that on Dingell’s suggestion, the NYSE did consider, but rejected, one proposal to make the exchange’s plan more politically palatable. That was a “sunset” rule requiring stockholders to reapprove the dual-class stock at regular intervals of several years.

“I tried to discourage that on the grounds it would have a behavioral effect on managements as the sunset date approached,” he said. “The incentives for dividend increases and pumping up earnings would be tremendous, just to get through the critical period. And every takeover artist in the country would have a well-marked calendar.”

Corporate finance experts have not exactly been idle while awaiting the Big Board’s next move and the SEC’s reaction. Already there are almost as many varieties of dual-class arrangements as there are takeover lawyers to contrive them.

There is the plain-vanilla version favored by Wang Laboratories and used as the model for such plans on the Amex: One class of stock has a set fraction of the votes awarded the superior class. (At Wang, it is 1/10.)

MCI Communications’ variation allows any stockholder to accumulate up to 10% of the total share votes; after that, each of his or her shares has only 1/100th of a vote.

Last year, another mutation arrived in the form of “time-phased” voting. At J. M. Smucker, American Family and Potlatch, shares carry one vote each unless they have been held by the same owner for four years or more; after that, they get 10 votes at Smucker and American Family and four at Potlatch.

Protects Insiders

A common thread colors most dual-class stock companies: They have groups of inside shareholders with commanding pluralities of shares. In effect, the dual-class proposals give the insiders additional protection against threats to their control.

“They want to be free to sell some of their stock and still control the company,” said Robert A. G. Monks, an independent spokesman for institutional investors.

At Potlach, for example, if 20.1% of the shares were long-term holdings getting four votes each and all others had only one vote each, the long-term shares would have more than half of the votes. Today, management and inside shareholders, who are likely to want to remain long-term holders, already own about 40%.

At Dow Jones & Co., the Bancroft family owned nearly 60% of the company when it proposed a dual-class plan in 1984 ostensibly to protect the independence of the Wall Street Journal.

As the company’s proxy statement explained, the plan was designed so “voting control by the Bancroft family will increase over time” to as much as 84%.

(The proposal was passed by the shareholders but has been tied up in a court challenge by dissident shareholders who contend that their rights have been circumscribed.)

The dual-class system established in 1984 at Hershey Foods was designed to maintain the control of the Hershey Trust, the foundation that supports the Milton Hershey School, an orphanage established by the company’s founder.

The foundation now controls 80% of the company’s votes--up from the 50.1% control that it exercised before its 1984 dual-class recapitalization.

“This wasn’t proposed or conceived as an anti-takeover measure,” said James Edris, Hershey’s investor relations officer, “because even before, an acquirer would have had to talk to the trust.”

But it did enable the trust to sell additional equity in the chocolate maker while maintaining, not to mention enhancing, its control of the corporation.

Most Effective Program

Perhaps the most complex and effective program for concentrating share votes in a small group is in place at Figgie International, an industrial conglomerate created over a couple of decades by Henry E. Figgie Jr.

In December, the company created two classes of stock: one with one vote per share and a second with 1/20 of a vote.

The company offered an additional dividend of 8 cents per share to encourage holders outside the management and Figgie’s family to keep the lesser class. Then the company’s employee retirement plan spent $12 million to buy up from outsiders as many full-vote shares as possible.

Finally, Figgie International limited the total votes any given shareholder could exercise to 10% of a stock class. After that point, each of the stockholder’s shares carries only 1/100 of a vote until he or she reaches 15%, the absolute limit.

A grandfather clause exempts Figgie’s own holdings from the restrictions, however. This and related provisions give the founder the potential to control, with his roughly 10% of Figgie International equity, almost 80% of stockholder votes.

Each of these companies implemented its plan with the approval of existing stockholders, a factor that lends them respectability. But it also has raised the question of whether shareholders really know what they are giving up when they award themselves second-class voting status.

There is not much data on how much money a share’s vote is actually worth, compared to the owner’s implicit right to a portion of the company’s profits. Since these two elements almost never trade separately, their respective contribution to a share’s price cannot easily be determined.

Payoff Varies Widely

While companies proposing dual-class stock issues generally pay off stockholders to take the lesser class by offering them a marginally higher dividend, the size of the payoff varies widely.

Hechinger Co. enticed its shareholders to exchange their one vote for 1/10th of a vote by offering them an additional dividend of 1 cent per share. At Waldbaum’s, a supermarket chain that created dual classes last year, the sweetener was 5 cents per share.

“It’s the best shareholder democracy money can buy,” said Joel Seligman, a law professor at George Washington University and a historian of the securities markets. “Getting shareholders to take a dual-class stock is not difficult. It’s just a question of how much it will cost.”

One prominent institutional investor, Dean LeBaron of Batterymarch Financial Services, has proposed allowing stockholders to trade their share votes separately from their stock’s income stream--in effect “renting out” their votes.

“That would create a secondary market for corporate control, which is worth much more than it’s priced in the market today,” he said.

Investment professionals argue that the demise of the one share, one vote principle has implications that range beyond the issue of shareholder protection.

An NYSE listing has been treated for so long as an implicit guarantee of product quality, it is said, that a change in listing standards will pollute the market.

“Nobody reads the certificate of incorporation when they buy a share in a company,” said Melvin Eisenberg, a professor at the UC Berkeley law school. “So you must make sure they have a reasonable expectation of what they’re getting.”

May Slash Standards

There is the possibility that, in their competition for corporate listings, the three major stock exchanges will pitch their standards to the lowest common denominator, a process termed a “race to the bottom.”

The lowest standards are those of the NASD, which has minimal listing requirements. The NASD last year considered raising its standards to more nearly match those of the Amex and the NYSE; its listed companies expressed such a decisive repugnance for tougher rules that the association quickly dropped the idea and commissioned a study from the University of Chicago justifying unequal voting classes on economic grounds.

The study by Daniel R. Fischel, a University of Chicago law professor and leading free-market theorist, argued that dual-class common stock allows owners of small and growing firms to obtain cheap financing in the stock market without relinquishing their control, thus preserving the ownership continuity that he contended was important for such firms.

Some critics suggest that concentrating share votes in a controlling bloc inevitably removes an important disciplinary force over management.

“One share, one vote prevents managers from insulating themselves,” said Seligman. “It preserves the takeover market, corporate elections and proxy battles as disciplinary devices. Once you sever that tie, you’ll have managements reviewed by boards of directors they themselves can fire.”

Political Analogy

Many supporters of the one share, one vote standard resort to political analogies in proposing its inviolability. Its comforting echo of the American political ideal of equality could be useful when the pendulum of government involvement in business swings away from deregulation.

“To say long-term stockholders should have more votes than others is like saying if you’ve only lived in a town for six months you shouldn’t have a chance to vote,” said Greta Marshall, investment director for the California Public Employees Retirement System.

Others reject the political analogy. “There’s no reason why the voting rules of government should resemble those of entities involved in the production of goods and services,” responds Fischel of the University of Chicago. “Many investors get no votes, and one should ask that if voting is an inviolate right for stockholders, why not for bondholders?”

Still, many securities professionals view the adulteration of voting rights as an echo of the unregulated markets of the 1920s, when non-voting common stock was decried as “the crowning infamy” of a system that allowed powerful bankers such as J. P. Morgan to control corporations with but a tiny portion of their equity.

One leading company, Dodge Bros., in 1925 issued $130 million worth of bonds and preferred and common stock carrying virtually no voting control; the voting stock remained in the hands of Dillon, Read & Co., an investment banking firm that held only $2.25 million of Dodge equity. Without fanfare, the NYSE listed the public shares for trading.

Late that year, a Harvard University professor named William Z. Ripley described the Dodge issue in a New York speech and warned: “General stockholders, to be sure, have always been inert, delegating most of their powers of election. But at worst they might always be stimulated to assert themselves. Under the new style of corporation, stockholders are boldly deprived of all rights in this direction.”

Created Political Stir

Ripley’s warning created a unique political stir. “He made his speech, and within a few months he was being escorted in to see Calvin Coolidge,” said Seligman, the George Washington University law professor. “The key theme Ripley emphasized was banker control of corporations.”

With the 1929 stock market crash and the Great Depression, control arrangements became suspect, and, upon the creation of the SEC and enactment of laws restricting bank trading in securities, they largely vanished.

By then, the NYSE was refusing to list non-voting stock. Having reduced its rule to writing, the exchange began to consider itself a guardian of inherent shareholder rights.

But the exchange has been known to bend the rules in the past. In 1956, Ford Motor sought and won listing on the Big Board even though control then and now rests with non-trading Class B shares held by members of the Ford family. In those days, Ford’s importance as a major listing was hard to ignore. Today, the same is true of GM, Dow Jones and scores of others.