Google's Sham Shareholder Democracy

Google (GOOG +1.78%) wants your shareholder capital, but doesn't want to give you a real say in how the company is run.

In a proposal listed in Google's 2013 proxy (link opens PDF), shareholder John Chevedden laments, "By allowing certain stock to have more voting power than other stock [Google] takes our public shareholder money but does not let us have an equal voice in our company's management. Without a voice, shareholders cannot hold management accountable."

Here's why I think he has a point.

Google's shareholder system
Since its initial public offering in 2004, Google has had two classes of stock. The stock bought by average shareholders is Class A stock, which has 1 proxy vote per share. Class B stock has 10 votes per share, and is owned by co-founders Larry Page and Sergey Brin, as well as chairman Eric Schmidt. Together, the three insiders controlled about 64% of the total vote as of Google's last 10-Q.

Because these insiders have a significant majority of the vote, they have effective control over any matters submitted to shareholders for review, including the selection of directors and approval of shareholder proposals.

Now Google wants to issue a third class of stock, Class C, that has no voting rights whatsoever, ensuring that Page, Brin, and Schmidt keep tight control over the company. Here's how it will work: For every share of Class A stock Google investors hold, the company will give them one share of Class C stock. While the price of each A share will decrease by half, the valuation of the C shares will start out as equal to that of the A shares, which means that the introduction of the new C shares won't dilute the holdings of Google's investors.

Management's defense
Google defends its dual-class voting structure (and future tri-class structure) by suggesting that it helps offer long-term stability that will promote better long-term returns for shareholders. Similar justifications are offered for the dual-class voting structures at Facebook, Groupon, LinkedIn, and Zynga.

This point has some merit. Sometimes shareholders can be focused on short-term returns that disrupt the long-term growth and survival of the company. As Google points out in its founders' IPO letter, Warren Buffett introduced the dual-class voting structure at Berkshire Hathaway to promote long-term success and to protect the company from shareholders who are overly focused on quarterly results.

However, as shareholders evaluate these arguments, I believe they should ask themselves whether they can trust each company's leadership to do what is best for shareholders. In evaluating Google's argument, shareholders should also remember that at Berkshire, Class A stock isn't limited to insiders (like it is at Google).

Risks at Google
In his shareholder proposal pushing for equal voting rights, Chevedden points out that this power structure has allowed Google to push through compensation packages that cannot be justified in terms of shareholder value. For example, in 2011 the company awarded chairman Eric Schmidt an equity package that was worth $100 million without any job performance requirements attached to it. Chevedden also pointed out that corporate governance organization GMI Ratings gave Google a D grade in 2012 and marked it as a "High Concern" for takeover defenses and "Concern" for executive pay.

I believe that Chevedden is right to be upset about these things, as I believe they show that Google leadership is abusing its control of the company to make decisions that are not in the best interests of long- or short-term shareholders.

Here's another reason I'm concerned. Proxy voting results from 2012 show that average outside shareholders at Google appear to be overwhelmingly against the dual- and tri-class voting structures.

Introduction of tri-class voting structure
Consider, for example the voting results on Google's 2012 proposal to introduce Class C shares that lack voting rights:

As the table shows, even though the measure passed, more than 85% of votes cast by outside shareholders were against the introduction of Class C non-voting stock. If Google's management had consistently acted in the long-term best interests of shareholders, and shareholders trusted them to represent their best interests in the future, I don't believe the results would have been so lopsided.

Shareholder proposal pushing for equal voting rights
Consider now the voting results on a 2012 shareholder proposal that pushed for equal shareholder voting (similar to the proposal on Google's 2013 proxy). 147,240,478 votes were cast for the proposal, and 686,884,401 votes were cast against it.

Given that B shares are all owned by insiders, and given that they all voted in favor of the tri-class voting structure that gives management more power over proxy elections, it's extremely likely that all 646,819,460 B share votes were cast against this proposal that would have given management less power over proxy elections.

If this is indeed the case, then more than 78% of votes cast by average outside shareholders supported equal voting rights. To me, this suggests that many shareholders have limited confidence that Google's leaders are representing their best interests.

The Foolish bottom line
Because Google insiders hold majority control of the votes, the shareholder proposal for equal voting rights essentially has no chance of passing. I think management's dismissal of the overwhelming support of this push shown by outside shareholders in 2012 suggests that the company is not interested in being accountable to shareholders.

I believe that, except in very rare cases, dual voting structures are bad for shareholders, and that they should pay extra careful attention to the trustworthiness of company leadership before investing in companies that limit their say.