On Monday Google announced that it is reorganizing its business and will create a new company called “Alphabet.” The internet businesses that generate most of the current company’s revenue (such as its ubiquitous search engine and YouTube) will be put into a subsidiary called “Google” that will be owned by Alphabet. The current company’s other endeavors (such as its attempts to build self-driving cars and Nest, its internet-connected household products business) will also be subsidiaries owned by Alphabet but will be separate from the subsidiary called Google.
The key to understanding why Google would shuffle its corporate structure is the company’s ownership. Even as it has become one of the world’s largest companies (its market value is currently more than $450 billion), Google’s founders have ensured that they retained control of the company and couldn’t get outvoted by other shareholders. That control has given them more flexibility to invest in longer-term ideas such as the self-driving cars without worrying that disgruntled shareholders would replace them with new executives.
By splitting the core internet business from these longer-term projects, the new company will be providing more information to investors about the financial performance of the core business and how much money is being invested in everything else. By trying to separate investors’ perceptions of how the internet business is performing from how much money is being invested in the longer-term projects, it could also (much like the company’s convoluted ownership structure) give Alphabet’s executives more flexibility to invest in the longer-term projects.
Whether this is good news or bad news for Google’s shareholders depends on how much confidence they have in the company’s executives. For those who believe that Google’s ownership structure gives its executives the freedom to make necessary long-term investments that will eventually pay off handsomely, the change should be cheered. Those who believe that Google’s ownership structure is a license to waste shareholders’ money on executives’ pet projects should have a less favorable assessment.
If you own stock in Google, you may have noticed something a bit odd: what used to be shares in GOOG stock on Thursday became shares in both GOOG and GOOGL, each worth about half as much as the GOOG shares used to be worth. What happened?
What happened was basically some financial trickery by Google founders Larry Page and Sergei Brin to make sure that they retain control of the company. Ordinarily when someone owns a stock, the financial investment comes with the right to vote on issues such as who should be on the company’s board of directors. As companies issue more shares of stock over time—perhaps to give stock grants to their employees or fund acquisitions of other companies—the voting power of the founders decreases.
Google’s founders didn’t want this to happen to them, so they split their stock into shares that have voting rights (GOOGL) and shares that don’t (GOOG). Now when they issue more stock, they can simply issue more of the ones without voting rights so that their voting power isn’t affected.
For investors in Google (and the many other companies that use similar ploys, such as Facebook and LinkedIn) this change may not be good news. Many executives have a tendency to grow their company and therefore enhance their power even if it’s not in the best interests of their shareholders (the technical term for this practice is “empire building”). Critics might contend, for example, that the money used for Google’s attempts to build self-driving cars or Facebook’s $19 billion acquisition of the messaging company WhatsApp could have been better utilized by simply returning it to shareholders.
Google’s tactics do have defenders, however: some argue that by not having to worry about losing control of their company to activist investors who are too focused on the short-term, cementing control of a company’s voting rights can allow founders to stay focused on the company’s long-term goals. So far investors seem to be buying this argument: Google, Facebook, and LinkedIn have substantially outperformed both other technology stocks and the broader S&P 500 index since the start of last year. Whether they’ll continue to outperform as the companies grow and the founders retain full control remains to be seen.