The Demonization of Dual Class Shares

Why have some corporate governance scholars (here, here, and here) advocated for imposing various sunset provisions on dual class shares?  After all, dual class share structures are simply the result of private ordering, that wonderful freedom provided by corporate law that, in the words of former SEC Commissioner Troy Paredes, “allows the internal affairs of each corporation to be tailored to its own attributes and qualities, including its personnel, culture, maturity as a business, and governance practices.” In effect, as several scholars have noted, “observed governance choices are the result of value maximizing contracts between shareholders and management.” For that reason alone, you would think we should keep our hands off of dual class shares.

Moreover, as Daniel Fischel explained many years ago:

As a theoretical matter, initial public offerings of limited or non-voting stock can never harm investors. The price of a security when a firm goes public reflects the value of that security to investors.  Investors only purchase a security when they estimate that the value of whatever rights and cash flows it carries equals or exceeds its price. If investors’ value voting rights and a firm fails to provide them, then the firm’s securities simply sell at a lower price. The organizers of the firm may be worse off, but investors are not.

Obviously, that is not enough reason for some academics and others who are strong supporters of the shareholder empowerment movement (the “movement”).  This movement, made up primarily of public pension funds with assets over $4 trillion and represented by the Council of Institutional Investors (CII), has led the charge against dual class shares for the obvious reason that it is a threat to the movement’s power.  That is, a public company that provides control to insiders through a dual class share structure can more easily resist the movement’s demands.

While the movement’s desire to eliminate dual class shares is clear, making understandable their advocacy of imposing an arbitrarily derived seven-year sunset provision on all dual class shares, what is going on with academics?  While the limited empirical research so far indicates that the value of dual class shares may recede after a certain number of years, the research is far from conclusive and nowhere near the point where it can justify a mandatory and systemic sunset provision.  So, why are academics in such a hurry to regulate?  Unfortunately, I think it has a lot to do with a conscious or unconscious agreement with the theory, articulated by Delaware Supreme Court Justice Leo Strine, that supports shareholder empowerment in a world of agency capitalism:

[T]here is only one set of agents who must be constrained—corporate managers—and the world will be made a better place when corporations become direct democracies subject to immediate influence on many levels from a stockholder majority comprised not of those whose money is ultimately at stake, but of the money manager agents who wield the end-users’ money to buy and sell stocks for their benefit.

For the sake of those 100 million retail investors and public pension fund beneficiaries who actually have money at stake, I hope I am wrong.   However, I think the acceptance of this theory by some academics and the bias it creates has a lot to do with the current demonization of dual class shares and not because it truly harms investors.

This post comes to us from Bernard S. Sharfman, who is the chairman of the Main Street Investors Coalition Advisory Council, an associate fellow of the R Street Institute, and a member of the Journal of Corporation Law’s editorial advisory board.  The opinions expressed here are the author’s and do not represent the official position of the coalition or any other organization that he is affiliated with.

 

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