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Google's governance comes up short

Posted: Friday, September 03, 2004

NEW YORK (AP) All the hype over Google Inc.'s initial public offering allowed one important tidbit about the company to get lost in the shuffle: Its corporate governance is anything but shareholder friendly.

Google may tout itself as being a company for the people, but it doesn't look that way when it employs such things as a two-tiered stock system and has a board of directors largely packed with insiders.

So much for its corporate motto ''Don't be evil.'' Its corporate ways may be a different story.

Investors, however, don't seem to be focusing on its governance shortcomings at least for now. Since the Internet search engine's much-awaited debut on the public markets on Aug. 19, the stock has mostly traded above $100, a gain of more than 17 percent from its IPO price.

But ignoring this issue could be a mistake.

''When evaluating a company, its fundamentals and valuations should be primary, but there is no question that they should also look at risk through a corporate governance prism, too,'' said Scott Kessler, an Internet equity analyst at Standard & Poor's.

That's just the way things have to go in the wake of all the recent business scandals. Companies are now under intense pressure to shore up their governance practices to ensure that their business dealings aren't tainted by conflicts of interest.

With so much attention on this issue, Google's decisions seem all the more surprising.

Institutional Shareholder Services, which advises big investors on governance, gives the online search firm a minuscule 0.2 percent score on its corporate governance quotient. By its analysis, if Google was part of the Standard & Poor's 500 stock index, its governance practices would rank last.

Among the most troublesome areas: Its establishment of a dual-class capital structure with unequal voting rights. Shares held by its founders, executives, directors and employees represent about 83 percent of the voting power, and carry 10 votes each vs. the one vote per share given to common stockholders.

And since a majority of the super-voting shares are held by Google's two founders, Larry Page and Sergey Brin, and its chief executive Eric Schmidt, they have significant influence over all matters requiring shareholder approval. That includes the election of directors, potential mergers and asset sales.

Also problematic is the independence of the board. Only three of Google's six outside directors have no link to the company, which is smaller than the two-thirds that ISS likes to see. In addition, the nominating committee, which chooses new directors, includes L. John Doerr, a venture capitalist who was an early Google backer. ISS is critical of his role because of his business relationship with the company, though he is considered independent under the listing rules of the Nasdaq Stock Market.

Google also allows for the repricing of its stock options. So if its stock price were to tumble, those inside the company especially top management could still get rewarded, while common shareholders are stuck with diminished returns.

And Google, following in the path of many Silicon Valley technology companies, won't deduct the cost of stock options from its earnings.

Still, Google can't be criticized all around. It has divided the power at the helm of the company by separating the chairman and CEO roles. The compensation of its board members is in the form of equity.

Ric Marshall, who is the chief analyst at the shareholder advocate organization The Corporate Library, thinks there are good points to its two-tiered stock system. As is the case at Warren Buffett's Berkshire Hathaway Inc., it allows those at the top to have a more focused, long-term approach, and makes them less concerned with whether quarterly earnings performance is pleasing Wall Street. The downside, however, comes when they make poor decisions, yet don't have to be accountable for them.

And while he agrees that Google's overall governance structure is less than desirable, he believes that it will improve its practices as it makes the transition from private to public company.

''Remember, Google is a new IPO. It is not a mature company, so it shouldn't be evaluated that way,'' he said.

The next year could be very telling for Google. As its initial shareholders begin to cash out of their stock positions, it will change its investor base. Whether those at the helm care to listen to what this new group has to say, may be another story.

Rachel Beck is the national business columnist for The Associated Press. Write to her at rbeck(at)ap.org



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