The Case for Dual Class Shares

In recent times, the simmering feud between the church of the one share-one-vote and the heretic believers in shares with unequal voting rights has boiled over, particularly in the U.S.

The arguments pro and con this type of capital structure are numerous and in some ways compelling. Thus, on the one hand, the increased activism of funds (including activist hedge funds) pushing and shoving boards and management of companies to boost share price or sell the business prematurely has reinforced the determination of entrepreneurs to insulate themselves against such pressures by adopting a dual class of shares at IPO time (more so in the U.S. than in Canada).

On the other hand, index funds and ETFs, now a large and growing investors[1] group and obliged to closely track the market value composition of a particular stock index, are thus precluded from manifesting their discontent about a corporation by simply selling its shares. They must wield influence on corporate management through their voting power (which, in dual class companies, is restricted) and by loudly voicing their frustration and disagreement. Not surprisingly, these latter investors are determined opponents of dual class shares and have lately and successfully urged Dow Jones and other index providers to exclude from their indices in the future any company with unequal voting rights.

They are also lobbying, not yet successfully, the SEC to prohibit this type of capital structure.

Some Facts

  • There is no incontrovertible evidence that dual class companies under-perform, in financial or stock market terms, traditional one share-one vote companies or are penalized by some discount on their value.

Table A

Empirical studies of the relationship
between dual class capital structure and company performance

2007 to 2018

Impact of DCS on performance Studies
Number %
Favorable or neutral 18  49%
Unfavorable 19  51%
Total 37 100%

Source: IGOPP compilation.

  • There is a tendency for results of older studies to be less favorable than those of more recent ones. Whether that is due to better governance at dual-class companies, better protection for minority shareholders, or better study design is unclear. Some recent studies deserve consideration because they are particularly well designed.
  • Thus, Cremers, Lauterbach, Pajuste (2018), who studied an extensive matched sample[2] of U.S. dual and single class firms from the time of their IPO over the period 1980 to 2015 reach important conclusions:
    • Dual class firms have a longer life than single vote companies and lower takeover activity; and
    • Dual class companies exhibit a valuation premium over single class firms, which lasts from six to nine years after their IPO, a result that contradicts the conventional wisdom. Dual class companies older than nine years tend to have lower valuations compared with companies with single class structures, though by this time many contaminating factors may have crept in.
  • Jordan, Kim, & Liu (2016), based on a matched sample of dual class and single class companies, found “that dual-class firms face lower short-term market pressure (fewer transient or short-term institutional holdings, a lower probability of being taken over, and lower analyst coverage) than propensity-matched single-class firms. Dual-class firms also tend to have more growth opportunities (higher sales growth and R&D intensity). The dual-class share structure increases the market valuation of high growth firms, in contrast to the finding in the literature that dual-class firms trade at lower valuations.” (Emphasis added)
  • Anderson, Ottolenghi and Reeb (2017) established that 9.4 percent of a sample of 2,379 firms (drawn from the Russell 3000) had a dual class of shares and “that these firms were significantly larger, older and better operating performers than their single-class firms in a matched sample”.

Sunset Clauses

The issue of “sunset clauses” has gained salience as institutional shareholders and various agencies try to curtail, rein in, and put a time limit on the relative freedom that a dual class of shares provides to entrepreneurs and family corporations.

An organized effort is already afoot, led by the Council of Institutional Investors to make it mandatory for future dual class companies to adopt a time-based sunset. At a minimum, companies considering a dual class IPO will be urged by investment bankers and sundry influencers to include some time limit on the benefits of superior votes. A movement may even emerge to pressure (or compel) dual class companies to adopt a time-based sunset long after their IPO.

It must be recognized that such a posture, if adopted in the past, would have meant that some growing companies would have been open to takeovers and their management subjected to all sorts of pressures long before they would have implemented fully their business model. Some advocates of sunset clauses put forth the optimistic (disingenuous?) argument that shareholders of both classes may well vote for a renewal of the time-based sunset for another period if they are happy with the way the company is run.

Unfortunately, no matter how stellar the performance of the company, if a vote were to be held to postpone the sunset due date, short-term funds of all stripes resorting to all types of financial maneuvers would flock into the company’s shares, eager to get their hand on the control premium that will result from the abandonment of the multiple voting class of shares. Then, it is highly improbable that a majority of the class of (new) shareholders with inferior voting rights would agree to a renewal of the dual class structure for another term.

Clearly, some advocates of sunsets do not accept, or are prepared to forego, the benefits and longevity of dual class family companies, which benefits are well supported by empirical research. They seem to believe that an economic system thrives best on creative destruction guided by an invisible hand and that stakeholders other than shareholders may, unfortunately but unavoidably, suffer collateral damage. That worldview is injurious to the social legitimacy of companies and is increasingly unacceptable to the broader society. In fact, Adam Smith believed “moral sentiments” were essential to the success of capitalism, and Joseph Schumpeter concluded that this kind of brutal capitalism would lead to some form of socialism!

Not only is there growing evidence of their better economic performance, but the coupling of dual class and family ownership brings about longer survivorship, better integration in the social fabric of host societies, less vulnerability to transient shareholders, and more resistance to strategic and financial fashions.

However, this precious form of ownership must come with appropriate measures to ensure and protect the rights of minority shareholders.

ENDNOTE

[1] The three major American managers of ETFs (Vanguard, BlackRock and State Street) in 2017 held 18 percent of all shares of the S&P 500 companies.

This post comes to us from Yvan Allaire, executive chair of the Institute for Governance of Public and Private Organizations (IGOPP). It is based on his recent paper, “The Case for Dual-Class of Shares,” available here.

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