Controllers Unbound with Lucian Bebchuk and Kobi Kastiel

In this episode, CII General Counsel Jeff Mahoney interviews Lucian Bebchuk, the James Barr Ames Professor of Law, Economics, and Finance, and Director of the Program on Corporate Governance at Harvard Law School and Kobi Kastiel, Professor of Law at Tel Aviv University. Professors Bebchuk and Kastiel are the co-authors of a recently issued research article, forthcoming in the Texas Law Review, entitled the “Controllers Unbound,” which analyzes how the relaxation of constraints on controlling shareholders at public companies incorporated in Delaware is expected to affect investors and the economy.  The article identifies risks for both public investors and the broader economy that may raise concern for those interested in investor protection and economic performance.

Transcript

SPEAKER_01 0:12

Welcome everyone. Thank you for listening to the Council of Institutional Investors Voice of Corporate Governance, the number one top corporate governance podcast of 2025 per million podcasts. I'm Jeff Lahoney, General Counsel of CII. My special guests today are Lucian Bebchuk, the James Barr Ames Professor of Law, Economics, and Finance, and Director of the Program on Corporate Governance at Harvard Law School. And Kobe Castile, Professor of Law at Tel Aviv University. Professors Bebchuk and Castile are the co-authors of a recently issued research paper entitled Controllers Unbound. The paper's available online on SSRN and the professors' home pages. Welcome, professors. Thanks for taking the time to speak with us today. Thanks for having us.

SPEAKER_03 1:00

Yes, great to be here.

SPEAKER_01 1:02

Professors, your research paper discusses the expected dire consequences of the recent relaxing of constraints on controlling shareholders. So let's begin by explaining to our listeners how do you define controlling shareholders? And can't you give us some current examples of controllers at U.S. public companies?

SPEAKER_02 1:22

Controlling shareholders are shareholders that have enough votes to effectively determine the outcome of the votes on a director election and other votes at the shareholder meeting. Now, in a company with a single class of shares, having 51% of the shares gives someone an absolute lock on control. But even a smaller fraction, say 30% of the shares, provides effective control. Now, in a company with a dual class structure, some shares have superior voting rights, such as 10 votes per share, while others have one vote per share. So in such a dual class company, a shareholder can have control with a minority or a small minority of the equity capital. Some of the largest and prominent companies in the US, such as Meta, Alphabet, Airbnb, Nike, and Comcast, have dual class structure. And as a result, a controller with a small minority of the equity capital. In Meta, for example, Zuckerberg has a local control with about 12% of the equity capital. In our study, we put forward evidence indicating that the incidence of control companies in the US has been increasing over time, in large part because dual-class shares have been widely used. Our evidence shows that there are now more than 900 controlled public companies in the US. The vast majority of them are incorporated in Delaware.

SPEAKER_01 3:05

Professors, you described last year's passage of Delaware Senate Bill 21 as substantially weakening the constraints on controllers of public companies. Can you provide our listeners with some background and an overview of Senate Bill 21?

SPEAKER_03 3:22

Sure, Jeff. So prior to SB21, there was a line of cases in the Delaware courts developed over a significant period of time that raised the hope that public investors in controlled Delaware companies would be substantially protected from controller conflicts of interest. Under this line of cases, cleansing a conflicted transaction would require a vote of approval from the unaffiliated shareholders. When you have such a vote, it would enable the public investors to protect themselves from a conflicted transaction that they view as very diverting. Post SB21, the situation is quite different. Delaware law is now clear that outside the special setting of a freeze-out, unaffiliated shareholders would not have an opportunity to vote to block a conflicted transaction they deem to be very diverting. All the controller would need to do is get an approval from two independent directors selected by the controller with this purpose in mind. Furthermore, the required approval process is one that controllers would find easy to satisfy and courts would largely be precluded from reviewing.

SPEAKER_01 4:51

Professors, your research paper identifies and analyzes several ways in which controlling shareholders should be expected to obtain large benefits at the expense of public investors. Can you give us an example?

SPEAKER_02 5:06

Of course. So in our article, we identify six main channels through which controllers could obtain substantial benefits at the expense of public investors. One of them is the ability of the controllers to introduce non-voting shares and use them to reduce their equity stake without weakening their local control. So to understand how this instrument works, consider the example of Zuckerberg, Mark Zuckerberg, and Meta. So in 2015, Zuckerberg was interested in cashing out a large fraction of his equity capital to fund the massive philanthropic activities. So a plan was designed by then Facebook board to distribute non-voting shares to all shareholders on a pro-ratter basis. According to that plan, if all shareholders will get two non-voting shares for each voting share they own, that will enable Zuckerberg to cash out about two-thirds of his shares without reducing his votes in any way. Now, in 2017, the plan was blocked by shareholder litigation. However, following SB21, controllers will be generally able to use such plans. And although these plans will provide more liquidity to controllers, they are also at the same time harming public investors. A move to a structure with a small minority or very small minority controller substantially increases the divergence between the interest of the controller and public investors. And there is a significant empirical evidence, which we discuss in the paper, indicating that such structures are associated with lower value for public investors.

SPEAKER_01 7:07

So that's one example of how controlling shareholders can obtain large benefits at the expense of public investors. Can you give us another example discussed in your paper that you're concerned about?

SPEAKER_03 7:19

Sure, Jeff, let me give you two other examples, and listeners can find a detailed description of the others in our paper if they have a time to take a look. So, one other example relates to sunset provisions. Many dual companies have adopted sunset provisions that prevent the dual class structure from continuing indefinitely. And actually, the CII has long been tracking all the companies with dual class structure that have sunsets on its website. We have reviewed all such sunset provisions in public companies, and we have found that a large majority of them do not require support from unaffiliated shareholders for their amendment. Therefore, without any protection against amendment in the charter, post SB21, controllers would generally be able to get sunset provisions removed, and the dual class structures in these companies would thereby become perpetual. Second example relates to what we call, quote unquote, a partial freeze-out. A controller would be able to get a major asset representing, say, 40% of the company's value sold to the controller at highly favorable terms and with little judicial scrutiny. The potential for value divergence from such transactions is substantial.

SPEAKER_01 8:51

Professors, your research paper predicts that the incidence of controlled companies will substantially increase in the future. So can you elaborate on the basis for your prediction?

SPEAKER_02 9:26

Now, we predict that going forward, controllers will prefer to retain their control and that they will use non-voting shares instruments to do so. And therefore, we will see more controlling shareholders, and the size of the control box should decline. Now, there are two major reasons for this conclusion. First, the relaxation of controller constraints post-SB21 should be expected to increase the value of control and the private benefits associated with it. So as a result, controllers will have stronger incentives to retain their local control. Second, and most importantly, controllers will not have any reason to forgo their local control over time. Post SB21, controllers will be able to introduce non-voting shares and use them, as we explained earlier, to cash out part of their equity or to raise extra funds for the company. And this is without any reduction in the number of votes they have. So to summarize, we explained that the future is likely to bring more controllers and lower control stakes, even in companies that went public with the single class structures. And moving to a world with small minority controllers would impose substantial losses on public investors and the economy in large?

SPEAKER_01 11:01

Professors, your research paper describes a dark future for long-term investors in the U.S. capital market. So, what actions, if any, can long-term investors take to prevent or at least limit the damage that you believe controllers will create for shareholders in our capital markets?

SPEAKER_03 11:21

Jeff, in putting forward the paper, our main goal was not to quote unquote scare people. It was to inform investors about new and substantial risks that they would be facing going forward. We believe that obtaining an understanding as to how risky particular governance structures are is very important for investors as they need to evaluate where to invest and how to engage. To mention one of the lessons for investors, going forward, investors should not feel protected by the mere presence of a seemingly protective provision in the Charter of Incorporation, because such a provision would not actually be protective unless the charter also prohibits amending it without an approval vote by unaffiliated shareholders. As I explained earlier, for sunset provisions, for example, our review of all such provisions in dual class structures found that most of them do not really provide any real protection going forward because of the ease with which controllers would be able to remove them. And to conclude with another lesson, what pressured Delaware to adopt SB21 and thereby establish rules making public investors so much worse off, was the fear that Delaware public companies would re-incorporate to other states. In some votes on proposed re-incorporations, such as the vote not so long ago in Tesla, which Jeff you might well remember, investors displayed substantial deference to the judgment of the board. In our view, going forward, investors should not view the selection of a jurisdiction as a business decision on which deference to the board is due. This issue involves a judgment about adequate governance, and institutional investors are in a very good position to make such judgments.

SPEAKER_01 13:37

That concludes our podcast episode. On behalf of the Council of Institutional Investors, I want to thank my special guests, Professors Kobe Castile, Professor of Law at Tel Aviv University, and Lucian Babjupp, the James Barr Ames Professor of Law, Economics, and Finance, and Director of the Program on Corporate Governance at Harvard Law School. If you have any questions or comments regarding this program, please feel free to contact me at Jeff. That's J E F F at CII.org. Until next time, I'm Jeff Mahoney. Thanks again for listening to the Voice of Corporate Governance.

SPEAKER_00 14:17

Thank you for listening to this episode of The Voice of Corporate Governance, brought to you by the Council of Institutional Investors. The Voice of Corporate Governance is a free, non-sponsored podcast that highlights critical developments in corporate governance and other important issues affecting institutional investors. The views expressed by those interviewed on the podcast do not necessarily reflect the views of CII or its members. For more information on CII and its policies of corporate governance, please visit our website at www.cii.org.