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Shareholder Democracy vs. Dual-Class Shares
1 / 3 / 2019
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No corporate stock practice in the US distorts shareholder rights more than dual-class shares. The voting structure of a stock has major implications for how much your clients can influence the companies whose shares they own.

As of 2017, 12% of S&P500 companies maintained a dual-class shares structure, including many of the high-profile technology companies that IPOed in the last decade, such as Facebook and Snap.1 This ratio holds for new companies, too. Of the 1242 companies that went public on US exchanges in 2017, 19% had dual-class shares structures with unequal voting rights.

Council for Institutional Investors

With dual-class (or multiple-class) shares, companies issue different tiers of shares that allow one group to have 2x, 3x, even 200x the votes of other shareholders. That means some people, usually founders and executives, can own a small portion of a company yet hold a disproportionate share of the voting power. Facebook’s Mark Zuckerberg owns just 1% of the company’s publicly traded stock but controls 60% of the voting power, meaning he can outvote everyone — even investors who hold a larger number of shares. Despite technically holding a minority of the shares, owners of the more powerful class of shares get a strong say in how the company is run while still benefiting from the financing provided by shareholders whose voices are minimized by the voting structure. Those lost voting rights have major consequences, since shareholder votes control everything from appointments to the board of directors to major changes in the company’s strategy.

Supporters of dual-class shares say that the system works in the best interests of the company by giving more power to shareholders who have the long-term interests of the business at heart and limiting the voting rights of investors who are more likely to be seeking short-term gains. They cite research that suggests it can even be good for stock performance. Others, including an SEC commissioner, say it’s deeply unfair and bad in principle, allowing power to be controlled by one group of people forever. Research has also found that companies with dual-class shares are likely to result in one group of investors pushing choices that benefit themselves, such as raising the CEO’s salary, all at the expense of regular shareholders.

The Council for Institutional Investors, a nonprofit, nonpartisan association of pension funds, endowments, foundations, and corporate funds, endorses the principle of equal voting rights for every share of a company’s common stock: one share, one vote.3 Recently, investors started pushing back. In September 2017, Facebook dropped its plan to create its own non-voting class of shares, and in May this year, the social network’s shareholders advanced a proposal to do away with the system entirely. One investor argued that “shareholder democracy is already lacking at Facebook,” while another criticized “the current structure’s inadequacies.” Snap went to an extreme with its IPO, giving zero voting rights to the regular class of shares available for the public to buy. Index providers retaliated by excluding Snap from their indices.

In 2018, investors tried to set up guardrails by asking other market participants to limit the impact of existing multiple-class share structures, and reduce the incidence of future IPOs with unequal voting rights.

  • Stock exchanges, including NASDAQ and the NYSE, were asked to amend their listing requirements in order to require new companies deviating from one-share, one-vote to sunset their dual-class shares structures within seven years of their IPO.
  • After consulting with institutional investors, index providers limited the inclusion of multiple share class companies from their indices. The three major index providers, S&P Dow Jones, FTSE, and MSCI, all conducted public consultations to gather feedback from investors; two of the three excluded new multiple-class listings from certain indices, while one also excluded existing constituents with multiple-class shares from its indices. With the growth of passive investing, inclusion in a major index has enormous impact on fund flows into a new company.

A growing area of compromise has emerged around sunsetting multiple-class structures after a set time period. Six percent of the companies that IPO’d in 2017 had such time-bound provisions. The CII compiled the range of approaches to sunset provisions in the table below:

Council for Institutional Investors

With several hotly anticipated IPOs expected in 2019, namely Uber and Lyft, investors will get a chance to see whether their demands were heard. If not, there’s no doubt that shareholders concerned with long term success and shareholder democracy will just get louder.
 
Sources

  1. Harvard Law School Forum on Corporate Governance and Financial Regulation
  2. excluding foreign private issues, special purpose acquisition companies, or master limited partnerships
  3. Council of Institutional Investors
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