The Myth of Dual Class Shares: Lessons from Asia

Companies with dual class shares have, as the term suggests, two (or more) classes of common stock. One class gives its holders voting power proportionate to their equity shareholdings. The other offers a group of shareholders, normally corporate insiders, weighted voting rights, which allow the insiders to retain control with less than majority ownership of the company.

The recent wave of high-profile technology giants, from Google to Facebook, that have gone public with dual class shares in the U.S. has led to the revival of the use of such share structures. Dual class shares have also gained traction among policymakers in Asia. Hong Kong, Singapore, and Shanghai, ranked among the top five global financial centers, have all recently altered their laws or listing rules to permit listing applicants to adopt dual class shares.[1] Last but not least, the UK Listings Review explicitly asks whether dual class listings should be permitted on the Premium Segment of the London Stock Exchange’s Main Market.

While there are conflicting views on the implication of separating insiders’ control from their cash flow rights, the debate over dual class shares has largely shifted to how to restrain the associated governance risks. Measures such as sunset provisions and limitation of voting differences are designed to restrain the control stemming from multiple classes of voting shares and provide mandatory safeguards to holders of inferior voting shares. However, these measures, intentionally or not, compromise the value of differentiated voting rights.

In a recent article, I argue that such measures are a double-edged sword: They not only help mitigate governance risks but also undermine the insulation of controllers from external investor and market influence. The scarcity of dual class shares in new IPOs in Hong Kong, Singapore, and Shanghai[2] reflects, at least partly, the reduced lure of such share structures when mandatory safeguards are stringent. This situation can be contrasted with the dual class IPOs in the U.S., where no such mandatory safeguarding measures exist. For example, in the U.S., 26 out of 134 newly listed companies in 2018, 25 out of 112 newly listed companies in 2019, and 32 out of 165 newly listed companies in 2020 adopted dual class shares.[3]

The main safeguarding measures, including sunset provisions, maximum voting differentials, and enhanced corporate governance standards, are ex ante strategies. They seek to prevent or deter potential managerial unaccountability and opportunism by restraining controlling shareholders’ ability to exercise their multiple voting shares. Because the stringent ex ante measures tend to over-restrain the controllers’ power and thereby compromise the benefits of weighted voting rights under dual class shares, it is worth considering ex post measures as an alternative.

My article points out that none of the leading financial centers in Asia has an effective and robust ex post regime such as private enforcement that relies on the financial incentives of a plaintiffs’ bar. This, perhaps, leads to those centers’ dependence on ex ante safeguards in checking agency costs and protecting investors. But the success of dual class shares lies in their market acceptance. If few or no companies choose to go public with such share structures, permitting dual class listings would be fruitless. Therefore, I suggest exploration of more ex post mechanisms, such as aggregate litigation through representative proceedings that provide aggrieved shareholders with remedies when problems from lack of managerial accountability occur, to reduce the reliance on ex ante constraints as mandatory safeguards.

The time has come for countries that restrict dual class listings, such as the UK, to seriously reconsider their stance on such share structures in order to attract IPOs from companies in the high-technology and innovative sectors and to broaden capital markets. This is, first, because the potential governance costs may be outweighed by the benefits of dual class shares, such as greater capital structure flexibility, enhanced protection of entrepreneurs’ idiosyncratic vision, and long-term focus. Second, constraints can be placed on such share structures to limit their negative impact. More important, while investor protection is essential, too many safeguarding measures would undoubtedly affect the intrinsic value of dual class shares. Thus, what policymakers and regulators should really focus on is how to strike a balance between maintaining a flexible capital structure and controlling the associated governance risks.

ENDNOTES

[1] For example, the Hong Kong Stock Exchange (HKEx) relaxed its restriction of one vote per share in its listing rules and implemented a new chapter on dual class listings in April 2018. In Singapore, the company law was amended by enacting a new provision permitting differentiated voting arrangements to replace the old provision on proportionate voting, and the Singapore Stock Exchange (SGX) permitted dual class listing in June 2018. In Shanghai, a new Sci-Tech Innovation Board was launched in the Shanghai Stock Exchange (SSE) and new listing rules were enacted in March 2019 to allow companies to go public with dual class shares.

[2] In Hong Kong, only two out of 218 newly listed companies in 2018, one out of 183 newly listed companies in 2019, and four out of 154 newly listed companies in 2020 adopted dual class shares. In Singapore, there is only a secondary listing on the SGX with dual class shares so far. In Shanghai, since the establishment of the SSE Sci-Tech Innovation Board, there has been only one listing application for an IPO with dual class shares. See HKEx 2019 Annual Market Statistics (December 2019) and HKEx 2020 Annual Market Statistics (December 2020); SGX Stock Screener at https://www.sgx.com/zh-hans/securities/stock-screener; SSE Market Data Overview, at http://star.sse.com.cn/en/marketdata/overview/.

[3] In particular, 13 out of 30 tech IPOs in 2018, 12 out of 40 tech IPOs, and 18 out of 42 tech IPOs in 2020 have adopted dual class shares. See e.g. Jay R. Ritter, Initial Public Offerings: Technology Stock IPOs (December 2020), at https://site.warrington.ufl.edu/ritter/files/IPOs-Tech.pdf.

This post comes to us from Min Yan, an assistant professor in business law and director of the BSc Business with Law program at Queen Mary University of London. It is based on his recent article, “The Myth of Dual Class Shares: Lessons from Asia’s Financial Centres,” available here.

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