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Google's Governance Falls Way Short

By Louis Lavelle Now that Google (GOOG) is a public company, shareholders might be wondering just what they've gotten themselves into. The answer is on page 29 of the latest prospectus released on Aug. 18. Co-founders Larry Page and Sergey Brin and CEO Eric Schmidt "run Google as a triumvirate," the prospectus declares. Notice the use of the present tense -- and a term of governance that implicitly ignores a role for the board, institutional shareholders, and, well, just about everyone else.

As audacious as "triumvirate" sounds, the corporate-governance issues with Google only start there. The head Googlers have seen to it that the company obtains all the benefits of public ownership -- with hardly any of the responsibility. And shareholders -- or at least the ones who own the Class B shares -- are pretty much powerless to do anything about it. Don't just take my word for it. According to proxy adviser Institutional Shareholder Services (ISS), if Google were part of the Standard & Poor's 500-stock index, it would rank dead last in corporate governance.

Oh, it has some shareholder-friendly provisions -- the nine-member board is elected annually, for example, and Google will have a nonexecutive chairman, and everybody on the board owns stock.

PROBLEMATIC OPTIONS. Missing are almost all the tools that shareholders in other public companies use to assert their rights as owners. Supervoting rights are accorded to the Class A shares, mergers could require the approval of investors representing 60% of the votes, and the board can change the bylaws without shareholder approval. All of which means investors have two choices: They can watch what happens or vote with their feet. Influencing how Google is run isn't an option.

What's more, under the terms of the stock-option plan, repricing is explicitly allowed -- so if the stock plummets, Google can reward those responsible by restoring the value of their options, even as regular shareholders give up their plans for early retirement.

Although more than 500 companies have voluntarily begun deducting employees' options expenses from earnings -- something that will likely be mandatory in a few months -- Google isn't among them. As a result, its earnings will be legally, but artificially, inflated, and shareholders who want to know the truth will have to comb through the footnotes. Of course, Google will continue to expense some stock-based expenses, such as payments to vendors -- about $230 million worth. But by not expensing employee options, it will avoid a huge hit to earnings.

HIGH-FLYING DEAL. The board also has its share of potential conflicts. The nominating committee, which chooses new directors, includes L. John Doerr, a partner at the venture-capital firm of Kleiner Perkins Caufield & Byers, an early Google backer. Under Nasdaq rules, Doerr is an independent director, but ISS considers him an "affiliated outsider" -- a nonemployee director who has a business relationship with the company. ISS considers that inappropriate for a committee that should be completely independent. Doerr, still in the IPO quiet period, didn't return calls for comment.

CEO Eric Schmidt may face questions about a business relationship with Google. Schmidt owned an interest in two jets that have been used by other Google execs for business travel. In 2003, Google paid the company that manages the jets $278,119, and reimbursed Schmidt more than $20,000 for their use. Schmidt is entitled to a portion of the profits earned by aircraft management company but has agreed to pay that money to Google. Governance experts argue that such "related-party transactions" -- which are fairly common -- represent potential conflicts of interest and should be eliminated. Google declined to comment for this story.

Then there's the issue of whether Google is a "controlled" company under Nasdaq rules -- an outfit where more than 50% of the voting power is held by a single individual, group, or other company. If so, Google can claim an exemption from some of the most important governance provisions of the post-Enron era, including the requirement that the board have a majority of independent directors.

"SERGEY & LARRY SHOW." With 84% of voting power in the hands of Google insiders, meeting the 50% threshold shouldn't be a problem. Yet, under Google's new corporate charter, the board must have a majority of independent directors, even if the company obtains the exemption. So there's no immediate benefit, right? Hold on. A unanimous vote of the Google board -- followed by approval of shareholders representing two-thirds of the voting power -- could repeal those provisions and allow Google to fill the board with insiders to its heart's content.

If that were to happen -- a big if, at this point -- all bets are off. Patrick McGurn, ISS's senior vice-president, says the exemption would strip away the few remaining safeguards that the Google triumvirate saw fit to include in its prospectus.

An insider-dominated board could easily pack the compensation committee with current and former execs and erect formidable takeover defenses such as staggered board elections. Greg Taxin, CEO of proxy adviser Glass Lewis & Co., says declaring Google a controlled company would leave small shareholders out in the cold. "Outside owners will demand protections," says Taxin. As a public company, Google "is no longer the Sergey & Larry Show.... They have to rely on formalities to ensure their money is well cared for."

INTEL'S EXAMPLE. The triumvirate says it opted for an unconventional system of governance because the traditional structures weren't good enough. Google execs, wary of being beholden to Wall Street's short-term financial interests, seem to believe that being responsible to shareholders will interfere with their ability to keep Google a leading innovator in a competitive market. That notion will no doubt come as a surprise to other innovative companies in competitive markets such as Pfizer (PFE) and Intel (INTC), which have sterling governance reputations.

In the end, how the Googlers manage their company may not make a difference. As long as it earns money, few investors will care that the CEO is doing business with his own company or that each one of their shares entitles them to a single vote while insiders get 10. But if and when the gravy train comes to a halt, the members of this triumvirate may wish they had spent a little more time making shareholders feel like they owned Google, too. With Ben Elgin in Silicon Valley

Lavelle is Management editor for BusinessWeek in New York

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