Commentary: Corporate Control Freaks

Investors, beware: Google and others are out to sidestep governance reforms

Attention, investors considering joining the rush to hand over $2.7 billion to Google Inc. in one of this year's hottest initial public offerings: You will be buying shares of a company that may ignore a key corporate-governance reform. Not all members of the board committee that determines the pay and perks of Google's execs are likely to be independent. Nor are all those on the committee that nominates Google's directors.

How can Google get away with this? The answer lies on page 89 of its prospectus. If shareholders representing two-thirds of the votes agree, Google may declare itself a "controlled company." As such, it will be exempt from new New York Stock Exchange and NASDAQ requirements that a majority of a company's board as well as all members of the nominating and executive compensation committees must be independent. Google declined to comment because it is in the standard quiet period before its offering.

Google's decision to consider an exception to the reforms is at the heart of a troubling issue. Stock exchanges adopted new rules in November to curb self-dealing and corporate abuse by making boards more independent of management. But the rules have a big loophole: Companies in which an individual, group, or another company holds more than 50% of their votes can ignore them.

Google is in good company. No one knows exactly how many companies are filing for exemptions and regulators won't have a count until yearend. But a long queue of companies ranging from cable-TV outfit Cox Communications Inc. (COX ) to Weight Watchers International Inc. (WTW ) seems to be forming. Newly minted public companies such as Orbitz (ORBZ ) and IPO candidates such as oil-and-gas exploration outfit W&T Offshore Inc. are also lining up. "It seems appropriate, given that the five founding airlines or their affiliates own approximately 68% of our stock," says spokeswoman Maryellen Thielen of Orbitz, which went public in December. W&T Offshore declined to comment.

Even mutual-fund researcher Morningstar Inc., which plans to go public, is tempted by the loophole. It warns investors in its prospectus that it will "rely on" the exemption, though it will have an independent board and committees for the "foreseeable future." Morningstar declined to comment.

Companies that skirt the reforms carry risks for investors. In the worst case, managements largely insulated from oversight by independent directors could end up like previous wipeouts controlled by insiders, such as Adelphia Communications Corp. And even in the best case, many could be shunned by institutional investors, potentially depressing their value. As part of an initiative to grade IPOs, Rockville (Md.)-based corporate governance adviser Institutional Shareholder Services Inc. has started giving negative marks to companies that plan to sidestep the reforms. Jay W. Lorsch, a professor specializing in corporate governance at Harvard Business School, warns that absent independent directors, "the majority shareholders can walk all over the minority."

Proponents of the exemption contend that investors benefit. Without it, tightly controlled gems such as Google may never go public. And people associated with a company, they say, could be the best candidates to oversee it. "They've got skin in the game," says Cox Communications Chief Financial Officer Jimmy W. Hayes.

Maybe so. But going around reforms negates the reason they were created in the first place -- to restore investor trust. "Companies need to go above and beyond the requirement," says Louis M. Thompson Jr., president and CEO of the National Investor Relations Institute. Investors who spot companies that don't should proceed with caution.

By Emily Thornton

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