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Aug 30, 2015

Taking the governance community's temperature on Alphabet

Greater transparency in Google and affiliated firms' performance is likely to raise more questions from shareholders about compensation and acquisitions

I’m a bit late to the topic, but Google’s transformation two weeks ago into a holding company called Alphabet has engendered some astute commentary in governance circles that merits further thought. By dividing the business into separate operating companies, of which the search/advertising business is just one – and the only one so far to generate a profit – Google’s leaders will certainly provide much-needed transparency about how each of the businesses is performing.

In a flash commentary piece for clients, John Wilson, head of corporate governance, engagement and research at Cornerstone Capital Group, suggests Alphabet be treated more as a public-private hybrid than as a public company from a governance standpoint, so investors are clear that ‘the function of the public business is to provide returns to shareholders net of ongoing investments in the private company.’ By private company, he means the various experimental businesses Google has bought or developed that have yet to turn a profit.

‘The new structure ensures there will be, at a minimum, independent accounting numbers produced for the Google business, and perhaps for the others as well,’ Todd Zenger, professor of strategy and strategic leadership at the University of Utah, writes in a piece for Harvard Business Review on August 11. He notes that the increased transparency of the new structure ‘further illuminates the disconnect between Alphabet’s various businesses’, underlining the question of why they are packaged together and enabling investors to clearly see the extent to which the search/advertising arm is subsidizing the other parts.

Numerous comparisons with Berkshire Hathaway have been drawn, pointing out that Google founders Larry Page and Sergey Brin have a long way to go to prove they are capable of managing a diverse mix of companies and generating satisfactory returns for each, as Warren Buffet has.

Besides transparency, basic corporate governance concerns have come up about the structuring of executive pay at the holding company and shareholder input into company decisions.

In his Cornerstone commentary, Wilson speculates: ‘Shareholders will be interested not only in compensation for the most senior executives but also for the CEOs of the operating companies. Questions about compensation may include: in the absence of clear financial metrics, how will executives be judged on the success of acquisitions? How will social and financial goals be balanced? What financial metrics are appropriate given the company’s strategy?’

In an email commentary, Dr Aleksi Aaltonen of Warwick Business School in the UK says the holding company structure could result in more successful products ‘if increased investor pressure imposes a healthy short-term perspective to product development or simply allows separate business units to operate more independently toward commercial success.’ But the same structure will make investors wonder whether the distinct businesses would do better as independent companies.

Earlier this year, an activist hedge fund directed the same question to a much more cohesive company, DuPont, which ultimately garnered broad shareholder support for its existing configuration. As other commentators have said, Google has largely shielded itself from such activism through a dual-class share structure that gives insiders more control over the company than their ownership stake warrants. We’ll see how long investors are willing to wait for Alphabet’s other constituent parts to prove they’re worth keeping.