Why Is Palantir’s (PLTR) Governance Structure So Egregious to Institutional Investors?: A Brief History of Shareholder Power
Disclaimer: https://www.transactionaldelights.com/disclaimers + I have a position in Palantir.
To understand why Palantir’s corporate governance regime is historically awful from the perspective of the investor, you first need a little bit of background on corporate governance in the United States. In a typical public company you have shareholders (retail, institutional, activist, etc.), exec. management (CEOs like Tim Cook at AAPL) and the Board (Directors like Chamath Palihapitiya at SPCE). Conceptually, having three disparate groups within one entity would make it seem like there is a balance of power, right? Well, historically that would be wrong.
In the past, the Board held all the power because shareholders in public companies tended to be mom and pop retail investors and therefore had no ability to act collectively. Accordingly, even though shareholders technically voted for members of the Board at the company’s annual meeting, because they had no leadership or ability to act collectively, the vote would typically be a rubber stamp. And in theory, Board members would hire exec. management to run the day-to-day operations with the Board supervising at 10,000 ft. So, really the only power shareholders had was to sell their shares if they didn’t approve of the Board/management.
And that’s why legislators enacted the federal legal regime[1] regulating public companies and securities. It was to protect the small guy – the investors from the Board and management by requiring public companies to make continuous disclosure on their business to shareholders[2] in the form of 8-Ks, 10-Qs, 10-Ks, etc. And its why Delaware law[3] still utilizes a legal concept known as shareholder primacy[4] and requires the Board to act as a fiduciary to the company’s shareholders.
The legal concept of shareholder primacy and the fiduciary responsibility of the Board to its shareholders still exists despite the rise of institutional investors and shareholder activists[5]. Why is the rise of institutional investors important? Well, because now collective action is a possibility and a vote for the Board actually has meaning. When three institutional investors dominate holdings for corporations in the S&P 500, companies cannot afford to turn a blind eye to their shareholders, whether the grievance is financial, operational, managerial, environmental, social, or governance based. And institutional investors can turn to shareholder activists when they don’t want to make their grievances public.
More recently, big tech companies have skirted the issue of investor sentiment by employing a dual class structure, which allows the Founder to hold a minority position of stock from an economic standpoint, but have a majority of the voting power, meaning that any major decision that a corporation makes would be determined by that Founder[6]. The market accepts this because shareholders typically buy into the founder mythology/narrative[7] and because some tech companies have incredible growth (i.e., facebook, alphabet, amazon, netflix, tesla, snowflake)[8]. And if you don’t like it as a shareholder you can always do what shareholders did in the past (before activists and institutional investors), which is to say you can sell. Non-tech companies, or traditional companies that try to employ a dual class structure are much less successful, and shareholders often assign a discount to the publicly traded stock (see VIAC vs. VIACA)[9] and do other weird things that shareholders do when they don’t get what they want.
Palantir is the latest evolution in the big tech dual class trend, and the most egregious because it establishes three classes – 496,530,269 shares of Class A outstanding (one vote per share), 1,089,984,003 shares of Class B (10 votes per share), and 1,005,000 Class F outstanding which is held in a trust and governed by the Founder’s agreement. So just off the bat, we can see that Class A shares technically have a voting right, but in practice have none. That’s pretty normal for a dual class company. But, what is this Class F? Oh, the “f” stands for founder[10] and has a variable number of votes per share:
As of today, in almost all instances the Class F common stock has 49.999999% of voting power of all of PLTR’s outstanding shares of stock. While that number might look less than 50%, in practice the Founder shares will never be outvoted, because just like the U.S. elections, 100% of the voter base never turns out[11]. You might have 75% of the outstanding at a good meeting[12].
But what about if the founders sell? Surely there must be some kind of limit to their functional control over PLTR? Well, no not really. Class F has 10 votes per share in instances where Founders have less than 100 million of all of PLTR’s equity securities. What? “Less, than” you say? Yes, that’s right. If the founders sell their shares (including classes of other shares) so that they collectively hold less than 100 million, they still retain enormous voting power. Why is that important? Because right now there are 496 million shares of Class A. If the founders sold down to 50 million shares they would still control PLTR.
So yeah, basically, if you want to invest in PLTR, you will always be under the thumb of the founders. And since a corporation’s life is supposed to be for perpetuity that means … welcome to your new overlords. And there you go wondering why shareholder activists exist. But, maybe Blackrock doesn’t care[13]. Although it’s kind of hard to reconcile ownership in this name with corporate purpose.
[1] The SEC, The Securities Act of 1933 and the Securities Exchange Act of 1934….as amended.
[2] Of course, there were exceptions to this – wealthy individuals capable of amassing enough shares to take on the corporations (like Robert Young in 1954 against New York Central Railroad).
[3] Where most public companies are incorporated
[4] The responsibility of the corporation is to maximize profits for shareholders. This sounds like it could lead to some sociopathic behavior, but it makes sense from the standpoint that shareholders are the owners of the company and the original provider of capital. Afterall, the traditional point of going public and beyond private investors was to raise capital. Does it make as much sense in today’s world when the need for public markets to access capital is diminished (although liquidity is still great), and when corporate responsibility has taken a more central stage? The former may be what PLTR is thinking with their governance structure
[5] The progeny of the 80s raiders
[6] The tech dual class is usually: Class A has one vote per share, and Class B has 10 votes per share. Class A is the one that is typically traded and available to public investors. There are also other kind of dual class structures employed by more traditional companies. For example, certain companies will allocate a minority number of members of the Board to Class A (say 4), and a majority number to Class B (say 8), and only the corporate insiders will hold the Class B shares. Accordingly, even if common shareholders elect all four members to the Board, they will always be outvoted by the insiders eight members.
[7] Bezos, Zuckerberg, Page, Gates, Jobs, Newman (oh wait), Kalanick (something’s not right here), Musk (yeah that’s it), Milton (uh…), Holmes (remind me again why there’s a mythology?)
[8] What is that the advertisements always say? If you invested $10,000 in Amazon’s IPO on day one, today that would be worth over $10 million.
[9] Although the discount doesn’t really make sense since VIACA shareholders don’t really have the functional ability to vote as they will always be a minority shareholder compared with Shari Redstone.
[10] It could stand for something else
[11] You know you screwed when the denominator is outstanding
[12] Like when shareholders are incentivized to vote for a M&A transaction and are on the receiving end of a 30% premium on their shares
[13] They currently own 0.1% of PLTR. Maybe corporate purpose just applies to the passive side.
