Lucian Bebchuk and Kobi Kastiel, leading scholars in corporate governance, have published an analysis highlighting potential governance flaws in SpaceX’s anticipated Initial Public Offering (IPO), which is projected to be the largest in history. While investor enthusiasm for SpaceX, driven by its ambitious goals and projected high valuation, is understandable, the authors argue that the company’s proposed corporate structure could significantly disadvantage public shareholders.
The forthcoming IPO, with reports indicating SpaceX aims to raise up to $75 billion at a valuation exceeding $2 trillion, presents a unique set of challenges. Bebchuk, the James Barr Ames Professor of Law, Economics, and Finance and Director of the Program on Corporate Governance at Harvard Law School, and Kastiel, Professor of Law at Tel Aviv University and Senior Fellow of the Harvard Program on Corporate Governance, assert that despite SpaceX’s impressive assets and growth prospects, its governance framework is poised to create substantial adverse effects for ordinary investors. Their analysis, based on reviews of a draft prospectus, focuses on three critical areas: the risk of a "small-minority controller," the perpetual nature of this control, and the incentives for adopting such a structure.
The Perils of a Small-Minority Controller
A central concern identified by Bebchuk and Kastiel is the potential for Elon Musk, SpaceX’s founder and CEO, to evolve into a "small-minority controller." This concept, detailed in their 2019 paper "The Perils of Small-Minority Controllers," describes a situation where an individual maintains dominant control over a company with a relatively small equity stake. This arrangement, they argue, leads to a misalignment of interests between the controller and public investors, fostering inefficiencies and value erosion.
Currently, SpaceX operates with a dual-class share structure. Publicly offered Class A shares carry one vote each, while Class B shares, predominantly held by Musk, carry ten votes per share. Musk reportedly holds approximately 40% of the company’s equity capital but controls about 80% of the voting rights.
The structure is designed to perpetuate and potentially strengthen Musk’s control over time. Any Class B shares sold by non-Musk shareholders will automatically convert to lower-voting Class A shares. Conversely, Class B shares transferred to Musk or affiliated entities will retain their super-voting power. Furthermore, the company can issue new Class B shares exclusively to Musk and his related entities, a mechanism that could be used as part of his compensation package, further solidifying his voting dominance.
Bebchuk and Kastiel contend that non-Musk holders of Class B shares at the time of the IPO have little incentive to prefer them over Class A shares. Given Musk’s entrenched control, their additional votes will likely have no material impact on their investment outcomes. Over time, these holders may opt to sell their shares, leading to the loss of superior voting rights. The authors also suggest that if Musk were to offer Class B holders an opportunity to exchange their shares for Class A shares, even at a slight premium, many would likely accept, further concentrating voting power with Musk.
This dual-class structure allows Musk to significantly reduce his equity stake without diminishing his control. If SpaceX achieves a $1.75 trillion valuation at its IPO, its shares would represent a substantial portion of Musk’s personal wealth. Standard risk diversification principles would naturally incentivize him to sell some of his holdings to reduce his exposure.
The analysis suggests that Musk could potentially sell all his Class A shares and a significant portion of his Class B shares (which would convert to Class A upon sale) while still maintaining over 50% of the voting power. If non-Musk Class B shareholders have already sold or exchanged their shares, Musk could retain a controlling stake by holding just over 10% of the outstanding Class A shares. In this scenario, Musk’s equity stake could fall to approximately 9.1% of the company’s capital, yet he would maintain absolute control.
The authors further elaborate that Musk could even reduce his equity stake further by leveraging non-voting shares. Citing their research in "Controllers Unbound," they explain that under current lax state law constraints, SpaceX could issue a large number of non-voting shares and distribute them proportionally to all shareholders. Musk could then sell all his non-voting shares, effectively cashing out two-thirds of his equity stake without any reduction in his voting control derived from his Class B shares.
The emergence of a small-minority or even very-small-minority controller introduces significant governance risks. Such structures can lead to costly distortions and inefficiencies in critical corporate decisions, including related-party transactions with Musk-affiliated entities, the allocation of investment opportunities between SpaceX and Musk’s other ventures, and the design of Musk’s compensation.
For instance, if SpaceX faces a decision where an action benefits Musk with $B but reduces overall shareholder cash flows by $L, Musk would only bear a fraction (μ) of the loss, where μ is his equity stake. He would still favor the action if B – μL > 0, or L < B/μ. This problem is exacerbated as μ decreases. Empirical evidence supports this, showing that lower equity stakes for controllers correlate with higher agency costs and reduced company value. Therefore, while acknowledging Musk’s visionary leadership, shareholders must recognize that the proposed governance structure could lead to value-decreasing distortions compared to a single-class, one-share-one-vote structure.
The Perils of Perpetual Control
Beyond the immediate concerns of minority control, Bebchuk and Kastiel highlight the enduring nature of SpaceX’s proposed governance structure. Even if Musk is currently the ideal leader, business history demonstrates that leadership effectiveness can wane over time. The authors argue that SpaceX’s governance framework is designed to be perpetual, lacking sunset clauses or other provisions to weaken Musk’s control, even if he ceases to be the most suitable leader.
This raises the specter of leadership succession. Will Musk, at the age of 84, be as effective as he is at 54? His most ardent supporters must concede a substantial risk that he may not be. Furthermore, if control is passed to a successor, such as one of his children, there is no guarantee that the heir will possess the necessary acumen.
In their paper "The Untenable Case for Perpetual Dual-Class Structure," Bebchuk and Kastiel analyze the costs associated with indefinite dual-class structures. They emphasize that the risk of a founder’s diminishing leadership capability grows over time. While one might argue that a controller would voluntarily relinquish power if it benefited the company, this is not guaranteed. Musk, or his successor, might fail to recognize their declining abilities. Crucially, because the majority of the costs associated with an ill-fitting leader are borne by public investors, the controller may prefer to remain in power to continue enjoying the private benefits of control, as exemplified by the case of Sumner Redstone, who maintained control of Viacom well into his nineties despite significant cognitive decline.
Does Musk Have Incentives to Avoid an Inferior Governance Structure?
A counterargument might propose that Musk has a vested interest in avoiding a value-decreasing governance structure, as any such deficiencies would be reflected in the IPO price. This perspective aligns with the Jensen-Meckling (1976) logic, which suggests that founders often internalize enough of the future costs of poor governance to incentivize efficient IPO structures.
However, Bebchuk and Kastiel argue that in SpaceX’s case, Musk may have incentives to favor a structure that maximizes his private benefits of control, even if it is detrimental to overall company value. Given his pre-IPO equity stake of approximately 40%, he would only bear a portion of the adverse effects imposed on public investors by an inferior governance structure.
To illustrate, consider a scenario where a chosen governance structure, compared to a one-share-one-vote system where Musk eventually relinquishes control, provides Musk with $100 million in private benefits (e.g., through related-party transactions or excessive compensation) but reduces the value of cash flows for all shareholders by $200 million. Musk would likely prefer this structure. He would fully capture the $100 million in private benefits, while only bearing 40% of the $200 million loss ($80 million). The remaining 60% ($120 million) would be borne by other pre-IPO shareholders. This highlights how Musk’s personal gain can outweigh the collective loss, incentivizing the adoption of suboptimal governance.
Broader Implications and Investor Considerations
The analysis by Bebchuk and Kastiel underscores the importance of scrutinizing corporate governance, even for investors who hold an exceptionally favorable view of Elon Musk’s leadership and believe founders inherently design efficient IPO charters. Their examination strongly suggests that despite SpaceX’s status as a highly anticipated IPO, it is likely to offer an inferior governance structure.
The potential implications for public investors are significant. The concentration of voting power in the hands of a small-minority controller, coupled with the perpetual nature of this control, can lead to decisions that prioritize the controller’s personal interests over the long-term value creation for all shareholders. This could manifest in less rigorous oversight, less favorable related-party dealings, and a reluctance to adapt to changing market conditions or leadership needs.
While SpaceX’s technological achievements and ambitious goals, such as its role in space exploration and potential for advancements in artificial intelligence, are undeniable drivers of investor interest, the governance framework demands careful consideration. The projected $2 trillion valuation suggests that the market is pricing in substantial future growth and innovation. However, the authors’ analysis suggests that this valuation might not fully account for the potential drag on value caused by structural governance issues.
Investors contemplating participation in the SpaceX IPO are advised to weigh the projected growth prospects against the inherent risks associated with the company’s governance structure. The potential for entrenchment, misaligned incentives, and a lack of robust accountability mechanisms could create a significant disparity between the potential upside and the actual returns realized by public shareholders.
Note: Lucian Bebchuk served as an expert witness in the Tornetta case, which involved Elon Musk’s compensation package at Tesla. This disclosure is provided for full transparency.
