Do Jubilee shares make any sense?

By Felix Salmon
April 16, 2012
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One of the more intriguing concepts to come out of the INET conference was Steve Keen’s idea for what he calls “Jubilee shares”. It’s not exactly new — he’s been writing about the concept since October 2010 — but he refined the concept for INET, and it has a bizarre kernel of genius to it, for all its flaws.

Here’s how it works. Right now, shares issued by a company represent the permanent equity capital of that company. If a company raises new equity capital, then the people buying that stock will have an ownership interest in that company in perpetuity. Under Keen’s proposal, none of that changes. But when those shares get sold, things start getting interesting.

At companies like Google, one class of shares automatically converts to another class when they’re sold. In Keen’s world, all companies would be a bit like Google. Not in terms of voting rights: each share would still carry the same voting weight. But there would be different share classes, all the same. Eight of them, to be precise.

As a rule, when companies issue Jubilee shares, they issue Class A shares — the highest class. And the way that Jubilee shares work, Class A shares would automatically convert to Class B shares when they were sold.

Now that wouldn’t be much of a change. Class B shares have all the same ownership and voting rights of Class A shares; the only difference between Class A shares and Class B shares is that when Class A shares are sold they become Class B shares, while Class B shares convert to Class C shares when they’re sold.

You can guess what Class C shares are like: they’re exactly the same as Class A shares and Class B shares, except that they convert to Class D shares when they’re sold. And so on and so forth, until you reach Class G shares. They convert to Class H shares when they’re sold, and Class H shares are actually very different indeed from all the others. Because Class H shares are not permanent equity capital at all: instead, they expire, worthless, on their 50th birthday.

If you hold Class H shares, you can trade in and out of them as much as you like: there’s no Class I. And you get full dividend payments and voting rights. But you also hold a piece of paper with an expiry date. As far as the cashflows from Class H shares are concerned, it’s basically just 50 years’ worth of dividends, and that’s it. (Although, if the company is sold, you get full participation rights.)

For a company like Berkshire Hathaway, which has little prospect of being taken over and which doesn’t pay a dividend, Class H shares would be close to worthless. On the other hand, for a company which is in clear decline and which is probably going to fail or get taken over in the next decade or two, Class H shares — at least the ones still far from expiry — would trade at only a very modest discount to Class A.

For companies going public, issuing Jubilee shares would be quite attractive, in some ways. The founders of Google and Facebook would feel much less need to give themselves super-voting rights, or to worry that IPO allocations are silly because they just end up getting flipped on day one, because the structure of the Jubilee shares would encourage shareholders to act like long-term owners rather than short-term traders.

For investors, Jubilee shares would also be attractive. Any company with Jubilee shares would have a very low stock-price correlation with the market as a whole — and investors like low correlations nearly as much as they like liquidity. And besides, Jubilee shares would be cheaper than normal shares, and it’s always nice to be able to buy equity in a company at a discount.

As for traders, Jubilee shares would be a very mixed bag. On the one hand, volumes would plunge. But on the other hand, bid-offer spreads would rise, and there would be a lot more opportunity to generate alpha and outperform the market by smartly navigating the various classes of stock.

Jubilee shares would work like a financial-transactions tax: on a mark-to-market basis, you’d take a loss every time you bought a stock. Shares would trade in seven main classes: A/B, B/C, C/D, and so on, with the first letter representing what the seller is selling, and the second letter representing what the buyer is buying. Since each class would trade at a lower price than the one before, the cost of doing a round-trip trade — of buying a stock and then selling it immediately — would be substantial. And I haven’t really thought through what might need to be done in the area of shorting and securities lending.

Still, there would surely be active trading, and the biggest profit opportunities, in Class H shares. Those shares would be highly specialized financial instruments, not least because they wouldn’t be fungible: each one would have a unique expiry date, and would be priced accordingly. Broker-dealers would trade them on the OTC market — it would be incredibly difficult to trade them on an exchange — and would tempt merger arbs and anybody else in the special-situations space with the promise of enormous profits. Dividend-related announcements would take on huge market importance, much more than they do now, and the difference between dividends and stock buybacks would go from being negligible to being enormous.

For all the active trading in such instruments, however, what you would not get would be a speculative bubble. The price of Class H shares would always be capped at the price of Class A/B shares, and Class A/B shares would be almost impossible to speculate in because volumes in that market would perforce be extremely low.

And so I think that Jubilee shares would indeed achieve what Keen intends them to achieve — the end of stock-market bubbles. They would also make investing in the stock market extremely difficult — something which can probably be considered a feature rather than a bug. Most investors would be forced to do their homework and really understand what they were buying; you wouldn’t get people logging on to E-Trade and buying thousands of dollars of a stock just because of something they saw on CNBC. And the huge current volume in ETFs — most of which is accounted for by speculative day-traders — would disappear overnight.

There are two ways that Jubilee shares might be introduced, neither of which is going to happen. One option would be for them to simply be imposed on the market by legislative fiat; that seems to be what Keen has in mind. That wouldn’t just be bad politics, it would be bad policy, since stock-market bubbles aren’t actually all that much of a problem. As we saw in 2000, they can wipe out enormous amounts of wealth when they burst, with surprisingly modest macroeconomic consequences, thanks to the fact that most stock-market investments are unlevered.

More to the point, legislating Jubilee shares would only make debt even more attractive than equity, as a funding source for companies — and that’s exactly what we don’t want to achieve. Unless and until Congress first abolished the tax-deductibility of corporate interest payments, the introduction of Jubilee shares would cause more harm than good in the markets as a whole, giving companies even more incentive to borrow money rather than to fund themselves with equity.

There is another way for Jubilee shares to arrive, however, and that’s for companies to issue them voluntarily. As far as I can tell, there’s no reason why a company couldn’t issue Jubilee shares rather than common stock tomorrow, were it so inclined. The market capitalization of any such company would certainly suffer: a founder wanting to maximize the mark-to-market valuation of her own stake in a company would never opt for such a structure. But for CEOs who prefer long-term control to paper wealth, Jubilee shares could be an attractive alternative to the current modish option — dual classes of shares with the founders’ shares having many more votes than everybody else’s.

But founders don’t need to issue Jubilee shares, now, thanks to the passage of the JOBS act. It’s now much easier for founders to retain control: with the 500-shareholder rule no longer in effect, founders can simply elect to stay private indefinitely, with a right of first refusal on any share sales and essentially complete control over where, how, and even whether their stock is traded. Given the attractions of private markets and the new powerlessness of the SEC when it comes to requiring companies to go public, it seems like Jubilee shares are to a large degree a solution to a problem which no longer exists.

Still, I’d love to see just one company try them out, if only to see what happens. Existing corporate stock can remain untouched, but new shares, be they sold directly to the public or given out to employees or used to buy some other company, could still be issued in Jubilee form. It would be fascinating to see where and how they traded.

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