Offloading the Burden of Being Public: An Analysis of Multiple Voting Share Structures

Anita Anand

Many large firms – Google, Alibaba and Fitbit to name a few — have multiple voting share structures (MVS) in which the firm issues two or more classes of shares, one to the public and the other to insiders (typically founders, promoters, management, private investors or board members). The shares that are issued publicly have limited voting rights while the class issued to insiders carries more voting rights, allowing them to control the company. The one-to-one ratio of votes per share prevalent in non-MVS firms does not exist.

MVS undermine corporate governance standards because outside shareholders carry a disproportionate share of the economic risk in the firm relative to their ability to influence the affairs of the corporation, and in some cases, these shareholders are totally unable to affect change in the corporation. In particular, public shareholders in MVS have diminished “ex ante” rights, effectively unable to exercise rights to which they would typically be entitled under corporate law in non-MVS structures including the ability to elect directors, approve financial statements, appoint auditors and affect change through their vote. Their rights are meaningless in the face of the proportionately greater economic risk that they bear.

The rationale for my argument against MVS is normative rather than positive. MVS firms, and the holders of the superior voting shares, should not be permitted to enjoy the benefits of being public without taking on the commensurate economic burden. In particular, a primary purpose of going public is to give the corporation the ability to access funding from individuals not associated with the corporation (i.e. from the public at large). It seems unfair to allow corporations – and by extension their shareholders at the time – to enjoy the benefit of going public without also taking on the corresponding burden of ensuring that the corporation’s public shareholders are protected with adequate governance and accountability mechanisms.

As a result, MVS weaken accountability mechanisms especially given that no fiduciary duty is owed as between shareholders.[6] MVS preclude shareholders from mounting successful challenges to the leadership of a public corporation as well as fundamental changes that it seeks to implement. MVS therefore potentially allow senior officers and directors to shirk their duties and/or divert profits. It is not necessarily the case that they will shirk and divert, but MVS insulate them and make it easier for them to do so. MVS offer them a built-in measure of entrenchment, but without the economic risk they would bear by purchasing shares themselves.

The group impacted the most in this analysis is minority shareholders who already face potential risks and abuses in the corporation. [7] The existence of MVS exacerbates their already tenuous legal position by removing their ability to participate in the governance of the corporation.

Taking the IPO Benefit with the Burden

Firms ‘go public’ because they seek capital to which they would not otherwise have access by remaining private. In other words, neither the exempt market nor other sources of capital (e.g. bank loans) is as attractive an option for these firms. By offering their shares to the public, firms spread the risk of ownership among a broad-based group of investors and can list their shares on a stock exchange so that their respective shares trade on the secondary market.

From then on, in a typical non-MVS firm, shareholders can elect the board, appoint auditors, and approve fundamental changes in the firm. In other words, they can participate in the governance of the firm at least from a distance by electing a board charged with acting in the best interests of the corporation and who appoints individuals who will be running the firm on a day-to-day basis (i.e. management). They exercise their ex ante rights.

Yet MVS disrupt this equitable balance by forcing the minority shareholders to carry the financial risk of investing in the corporation without having the corresponding power to elect the board or exercise other fundamental rights. Under MVS, common shares essentially function as preferred non-voting shares with shareholders being unable to participate in the life of the corporation. There is an inherent unfairness in this structure. An MVS structure taken to the extreme places the firm in the hands of a few individuals. This means that when things start to go wrong, it becomes much more difficult, expensive and time consuming for minority shareholders to bring about change.

Perhaps the issue here is the dominant view of the corporation being based in contract.[8] MVS are permitted because they represent free contracting between investors and the firm. But the relationship is not simply contractual; it has a securities regulatory overlay. That overlay is premised on the principle of investor protection, which when put into practice, does not allow the securities regulator to overlook acts of the public corporation that silence investors by preventing them from participating in corporate decision-making.

Furthermore, as the Supreme Court of Canada has held, securities regulators have a legal duty to act in the “public interest” and to protect the public on a prospective and preventative basis.[9] Therefore, the securities regulatory mandate arguably compels securities commissions to do more to protect minority shareholders. In other words, the role of the securities regulator is at least in part to ensure that the capital markets, and especially investors in those markets, are protected. Exercising this power may mean that MVS structures, which effectively create inequality as between minority shareholders and insiders in corporate decision-making, should be prohibited.[10]

Regulatory Reform

Of course the ultimate question is: in lieu of prohibiting MVS, what is the securities regulator to do? If they are unwilling to ban MVS altogether, securities regulators should consider the following policy options.

First, they should require that issuers subject their MVS to a sunset provision. Once a company goes public, the MVS structure would only be permitted to remain in place for a limited period of time. This policy option would ameliorate some – but not all – of the problems posed by MVS to the ex ante rights of minority shareholders by endowing them with effective voting rights in accordance with their level of economic risk once the sunset period expires.

A second, related option would be to subject the terms of the MVS buyout contemplated by the sunset provision above to certain procedural safeguards upon their collapse into a single class at the expiration of the sunset period. In particular, the terms of the MVS buyout should be subject to a majority of the minority vote, a fairness opinion and a mandatory recommendation of a special committee of the board formed for the purpose of evaluating the transaction. These safeguards would mitigate the accountability problems to which MVS give rise as a result of their diminishing effect on the minority shareholder franchise, and would go a long way in protecting against unfair transactions.

Finally, securities regulation should introduce rights for minority shareholders in MVS structures in change of control transactions. A rule that forces MVS firms subject to a hostile bid to ensure that all shareholders have a number of votes proportionate to their economic interests (e.g. in the event that a large percentage of equity holders tenders into a hostile bid) is a minimum. A similar rule is warranted in the case of changes of control by means other than a takeover bid, such as a proxy contest.  In other words, reform efforts must ensure that minority shareholders remain on a one-to-one footing with all shareholders regardless of the proposed change of control transaction and the means by which it occurs.

ENDNOTES

[1] Henry Hu & Bernard Black, Debt, Equity, and Hybrid Decoupling: Governance and Systemic Risk Implications, 14 E. Fin. Mgmt. 663, 666 (2008): “Some of these rights are economic, including dividend, liquidation, and appraisal rights under corporate law. Some rights are not purely monetary, including voting rights, director fiduciary duties, rights to bring suits and inspect corporate records, access to corporate proxy machinery…. Some of these rules are based on formal record ownership (even where the record owner passes voting rights to an economic owner); some are based on who holds voting rights. However, persons who have economic ownership but not voting rights are regulated lightly or, often, not at all.”

[2] Stephen M. Bainbridge, What To Do About Dual Class Stock (If Anything)? Stephen Bainbridge’s Journal of Law, Politics, and Culture, November 15, 2015, http://www.professorbainbridge.com/professorbainbridgecom/2015/11/what-to-do-about-dual-class-stock-if-anything.html.

[3] Luigi Zingales, The Value of a Voting Right: A Study of the Milan Stock Exchange Experience, 7 Rev. Fin. Stud. 125 (1994).

[4] For example, see Tian Wen, You Can’t Sell Your Firm and Own it Too: Disallowing Dual-Class Stock Companies from Listing on Securities Exchanges, 162 U. Pa. L. Rev. 1495 (2014), 1497, citing NASDAQ, Inc., NASDAQ Stock Market Rules IM-5640 (2014), http://nasdaq.cchwallstreet.com/NASDAQ/Main; NYSE Euronext, Inc., NYSE Listed Company Manual § 313.1 (2014), http://nysemanual.nyse.com/LCM (same); NYSE Euronext, Inc., NYSE MKT LLC Company Guide § 122.01 (2014), http://wallstreet.cch.com/AMEX/CompanyGuide.

[5] See Tara Gry, Dual-Class Share Structures And Best Practices In Corporate Governance, Parliament of Canada (August 18, 2005), http://www.parl.gc.ca/Content/LOP/ResearchPublications/prb0526-e.htm: “An estimated 20% to 25% of companies listed on the TSX make use of some form of dual-class share structure or special voting rights.”

[6] Jeffrey G. MacIntosh et al., The Puzzle of Shareholder Fiduciary Duties, 19 C.B.L.J. 86 (1991).

[7] Jeffrey G. MacIntosh, Minority Shareholder Rights in Canada and England, 27 Osgoode Hall L.J. 561 (1989) at 562 states, “Majority rule has been transformed slowly over time, with increasing concern on the part of courts, legislators, and administrators for the protection of minority shareholders….”

[8] See Michael Jensen and William H Meckling, Theory of the Firm: Managerial Behavior, Agency Costs and Ownership Structure, 3 J. Fin. Econ. 305 (1976).

[9] Committee for the Equal Treatment of Asbestos Minority Shareholders v. Ontario (Securities Commission), [2001] 2 S.C.R. 132 (Can.) [Asbestos].

[10] It should be noted that this legal change could be efficient: Amoako-Adu et al. found that elimination of the MVS structures in certain Canadian firms increased stock prices and improved the liquidity of the stock: Ben Amoako-Adu et al., Unification of Dual Class Shares in Canada with Clinical Case on Magna International, Capital Markets Institute at the Rotman School of Management, University of Toronto, https://www.rotman.utoronto.ca/-/media/Files/Programs-and-Areas/Institutes/CapitalMarkets/research/Unification%20Magna%20Research%20-Oct%2011.pdf.

The preceding post comes to us from Anita Anand, J.R. Kimber Chair in Investor Protection and Corporate Governance, Faculty of Law, University of Toronto. The post is based on her article, which is entitled “Offloading the Burden of Being Public: An Analysis of Multiple Voting Share Structures”, forthcoming in Virginia Law and Business Review (10:3) and available here.