We’ve commented from our pit here about the arrival on the stock market of app-based ride-hailing companies. You may even have seen the promotion efforts going on about the forthcoming Lyft initial public offering. As we’ve commented before, this will bring to the public markets the first app riding service company. Alongside Uber and others, these companies are insurgents in the comfortable cartel world of taxi firms.
Now what caught our eye recently was this article in the New York Times:
[perfectpullquote align=”full” bordertop=”false” cite=”” link=”” color=”” class=”” size=””]Lyft and Pinterest Won’t Be Giving Shareholders Much Say[/perfectpullquote]
What’s going on here? Well these companies are planning dual-voting class stock issues. As the NYT goes on to say, not only are shareholders potentially buying into a highly competitive business that—collectively—hasn’t made a bean of profit (mañana, guv, as my black cab driver would say about that), new shareholders aren’t even going to be able to influence the incumbent management:
Under the proposed IPO terms, the two founders Logan Green and John Zimmer will end up with 5% of the shares but will have 49% voting control. Um, we ask, who has the other 1.1% to give them legal control? But given their combined voting power, they don’t really need anyone else.
Now we can argue whether this is a good idea or not. It’s not, in our view. Think what is happening here. The shareholders get control rights without putting a huge amount of skin in the game (to be fair, they have some).
But one thing economics tells us (as Tim is fond of reminding the faithful reader of these pages) is that it’s all about incentives. What do those putting up capital want? Well, it’s a decent return. What do the owners want? Well, many things really. There’s a nice literature on the motivations of founders. Some, of course, maybe even a lot, of what they seek is wealth. But not all. And it’s here that the problem arises.
Owners are just that. They have a different utility function, to use a fancy piece of economic jargon, for what they want to see happen. Maybe, they’re not so keen on turning that profit. Or fancy a spanking new corporate HQ rather than return cash to shareholders. We can think of several tech firms that are keen on nice palaces. Who’s to stop them? They effectively control the business.
And it’s no good arguing that companies like Lyft with their founder-heavy control have done well in the past compared to firms with widely dispersed ownership. It’s the wrong argument, really.
Where we should be looking is at what happens when we see conflicts between an entrenched management and outside shareholders. This is where the problem arises, not in their performance which will, if we look at enough of them, be average. Consider this: every other shareholder in Lyft will have to vote against the founders to win a stockholders’ resolution. When is that likely to happen? Well, eternity’s a long time, so it’s possible.
And when it comes to these conflicts, the relevant research literature on the topic is in no doubt that failing to align the incentives of managers and shareholders is a recipe for disappointment for the latter. Once they get the cash, there’s nothing to stop Green and Zimmer from squandering it on their pet projects. Projects that won’t necessarily turn a tidy profit for shareholders. We have an example in Alphabet. The company has sponsored and invested a huge sum in moonshots and yet…and yet, they still have to pay dividends. What’ll it be like at Lyft where the corporate governance is shakier?
If one’s a rationale thinker, with Lyft and others of their ilk, barge poles and distance spring to mind. But investment bankers have to earn those nice big fees that allow them—yes!—to use those same apps to scoot from meeting to meeting in London or New York City. They’ve used the service and can vouch for how wonderful it is. Now go ahead and buy the stock.
But wonderful as using your mobile (cellphone to North Americans) for said rides, as we previously commentated and won’t repeat here, there’s a sea of money between having a good idea and making it tick in profitability terms.
We’re just happy to be a spectator on this one. Really. Now let me just use my app to get me to my next appointment…