A relic of the dot-com era may prove useful in attracting investors seeking specific exposures that are ESG-aligned.
By Roberto L. Reyes Gaskin and Anna Ngo
Shareholders, regulators, and other stakeholders continue to drive the integration of environmental, social, and governance (ESG) considerations into corporate strategy and practice. Recent surveys of institutional investors revealed that 22% expected their portfolios to be more than 75% aligned with ESG in the next two years,[1] while 62% stated that an ESG-aligned portfolio was more likely to exceed the market rate of return.[2] Many publicly traded companies are therefore engaged in integrating ESG into their business models, value chains, practices, and reporting.
In a concurrent trend, a number of conglomerates have completed, or announced plans to proceed with, spin-offs of one or more business units or other reorganizations to form multiple publicly traded companies according to end market, service, or product type.
Tracking stocks are an established alternative to this trend of corporate separation, and can potentially be repurposed by large publicly traded companies to serve ESG integration.
What Are Tracking Stocks?
Tracking stocks (also called targeted stocks) offer exposure to the profits and losses of a particular business unit (the Tracked Business) while permitting such Tracked Business to remain fully consolidated within the wider parent business (the Whole Business). Tracking stocks were popular in the dot-com era of the late 1990s and early 2000s as companies sought to unlock value from divisions, including recently acquired ones, that were engaged in e-commerce and related activities.
The typical features of tracking stocks are:
- Exposure to the assets, liabilities, profits, and losses of the Tracked Business from a combination of internal operational and accounting reporting lines and allocation decisions
- The right to receive dividends of the Tracked Business
- Voting in respect of the Whole Business, usually on a pro rata basis according to the weight of the Tracked Business in respect of the Whole Business’ capitalization
- Liquidation rights in respect of the Whole Business or preferred liquidation rights in respect of the Tracked Business
How Can Tracking Stocks Fit With ESG?
By establishing tracking stocks, a company could attract pure play investors seeking specific exposures that are ESG-aligned. For example, an automotive company could create an electric-vehicle tracking stock, or a fast-moving consumer goods manufacturer could create a meat-substitute tracking stock. This would permit the Whole Business to continue to be operated as an integrated enterprise without a spin-off of the Tracked Business that may not yet be scalable to be separately viable. Additionally, maintaining unity of the Whole Business could increase shareholder value to both constituent parts if there are significant synergies between the two units. Tracking stocks may facilitate measuring key performance indicators of the Tracked Business over time and additionally can be used as acquisition currency when acquirers purchase ESG-aligned businesses that are complementary to their strategy, similar to how tracking stocks developed during the dot-com boom.
The graphic below illustrates how a tracking stock is structured.
Tracking stock holders are shareholders of the Whole Business that have a degree of exposure (depending on the structure of the tracking stock and within the confines of corporate law of the jurisdiction of the Whole Business), including potentially rights to dividends and liquidation proceeds from the Tracked Business in preference to ordinary shareholders of the Whole Business. From a securities law perspective, a tracking stock is a separate class of the Whole Business’ shares that trades on a separate line than the Whole Business ordinary shares.
Legal Considerations
Before establishing a tracking stock, the board of directors and shareholders of the Whole Business should carefully consider the following:
- Defining the rights of the tracking stock shareholders in respect of dividends, governance, liquidation rights, and conversion and/or redemption
- Managing competing fiduciary duties of the board in respect of the new class of shareholders
- Completing an allocation of the assets and liabilities to delineate and virtually separate the Tracked Business from the Whole Business at inception
- Agreeing a contractual framework as to reporting and governance lines
- Preparing an information document (proxy statement) for the shareholder vote on changing the bylaws and, depending on the listing regime, a prospectus to list the tracking stock
The jurisdiction of incorporation of the Whole Business can determine the bundle of rights that will define the tracking stock. Well established in Delaware corporate practice, tracking stocks have been or can theoretically be implemented in England, France, Germany, and Italy, including by recourse to the preference share statutory regime in France, Germany, and Italy.
Endnotes
[1] The ESG Global Survey 2021, BNP Paribas (September 2021). Available online at: https://securities.cib.bnpparibas/esg-global-survey-2021/.
[2] 2021 ESG Investor Insight Report, Natixis (April 2021). Available online at: https://www.im.natixis.com/uk/research/esg-investing-survey-insight-report.