The Rising Tide of Dual-Class Shares: Recipe For Executive Entrenchment, Underperformance and Erosion of Shareholder Rights
By: Blair A. Nicholas and Brandon Marsh
Recent developments and uncertainties in the
and other institutional investors are standing up
securities markets are drawing institutional investors' against this trend. But in the current environment of
attention back to core
permissive exchange rules
principles of corporate
allowing for such dual-
governance. As investors
class or multi-class stock,
strive for yield in this
there is still more that
post-Great Recession, low
investors can do to protect
interest rate environment,
their fundamental voting
climb amid the promises
The problem of dual-class
of rapid growth. But at the
stock is not new. In the
same time, some of these
1920s, many companies
went public with dual-
are asking investors to give up what most regard as a fundamental right
The problem of dual-class stock is not new. In the 1920s, class share structures
many companies went public with dual-class share structures that limited "common" shareholders' voting rights.
that limited "common" shareholders' voting
of ownership: the right
rights. But after the Great
to vote. Companies in the technology sector and
Depression, the NYSE the dominant exchange at
elsewhere are increasingly issuing two classes or even the time adopted a "one share, one vote" rule that
three classes of stock with disparate voting rights in
guided our national securities markets for decades.
order to give certain executives and founders outsized It was only in the corporate takeover era of the
voting power. By issuing stock with 1/10th the voting 1980s that dual-class stock mounted a comeback,
power of the executives' or founders' stock, or with
with executives receiving stock that gave them
no voting power at all, these companies create a
voting power far in excess of their actual ownership
bulwark for managerial entrenchment. Amid ample
stake. Defense-minded corporate executives left, or
evidence that such skewed voting structures lead to
threatened to leave, the NYSE for the NASDAQ's
reduced returns long run, many public pension funds or the American Exchange's rules, which permitted
dual-class stock. In a race to the bottom, the NYSE
Employees Retirement System (CalPERS), which
suspended enforcement of its one share, one vote
manages the largest public pension fund in the United
rule in 1984. While numerous companies have since
States, filed suit in late 2016.1 Both suits are currently
adopted or retained dual-class structures, they remain pending.
definitively in the minority. Prominent among such
outliers are large media companies that perpetuate
To forego the ownership gymnastics of diluting
the managerial oversight of a particular family or
existing shareholders' voting rights by issuing non-
a dynastic editorial position, such as The New York
voting shares as dividends, the more recent trend is to
Times, CBS, Clear Channel, Viacom, and News Corp. set up multi-class structures with non-voting shares
from the IPO stage. Alibaba was so intent on going
Now, corporate distributions of non-voting shares are public with a dual-class structure that it crossed the
on the rise, particularly among emerging technology
Pacific Ocean to do so. The company first applied
companies. They have also been met with strong
for an IPO on the Hong Kong stock exchange, but
resistance from influential institutional investors. In
when that exchange refused to bend its one share,
2012, Google which already protected its founders
one vote rule, the company went public on the NYSE.
through Class B shares that had ten times the voting
LinkedIn, Square, and Zynga also each implemented
power of Class A shares moved to dilute further
dual-class structures before going public. Overall,
the voting rights of Class A shareholders by issuing
the number of IPOs with multi-class structures is
to them third-tier Class
increasing. There were only
C shares with no voting
6 such IPOs in 2006, but
rights as "dividends."
that number more than
Shareholders, led by a
quadrupled to 27 in 2015.
The latest example is Snap
fund, filed suit, alleging
Inc., which earlier this year
that executives had
The Snap IPO in particular has elicited investors' concluded the largest tech
breached their fiduciary
rebuke. After Snap announced its intended issuance of IPO since Alibaba's, and
duty by sticking investors non-voting stock, CII sent a letter to Snap's executives, took the unprecedented step
with less valuable non-
cosigned by 18 institutional investors, urging them to of offering IPO purchasers
voting shares. On the eve of trial, the parties
abandon their plan to "deny outside shareholders any voice in the company."
no voting rights at all. This is a stark break from
agreed to settle the case
tradition, as prior dual-
by letting the market decide the value of lost voting
class firms had given new investors at least some
rights. When the non-voting shares ended up trading albeit proportionally weak voting rights. As
at a material discount to the original Class A shares,
Anne Sheehan, Director of Corporate Governance
Google was forced to pay over $560 million to the
for the California State Teachers' Retirement System
plaintiff investors for their lost voting rights.
("CalSTRS"), has concluded, Snap's recent IPO
"raise[s] the discussion to a new level."
Facebook followed suit in early 2016 with a similar
post-IPO plan to distribute non-voting shares and
Institutional investors such as CalSTRS are
solidify founder and CEO Mark Zuckerberg's control. increasingly voicing opposition to IPOs promoting
Amid renewed investor outcry, the pension fund
outsized executive and founder control. In 2016, the
Sjunde AP-Fonden and numerous index funds filed
Council for Institutional Investors ("CII") called for
a suit alleging breach of fiduciary duty. Also in 2016,
an end to dual-class IPOs. The Investor Stewardship
Barry Diller and IAC/InterActive Corp. tried a similar Group, a collective of some of the largest U.S.-based
gambit, creating a new, non-voting class of stock in
institutional investors and global asset managers,
order to cement the control of Diller and his family
including BlackRock, CalSTRS, the Vanguard Group,
over the business despite the fact that they owned less T. Rowe Price, and State Street Global Advisors,
than 8% of the company's stock. The California Public launched a stewardship code for the U.S. market in
January, 2017. The code, called
addition to the immediate deprivation of investors'
the Framework for Promoting Long-Term Value
voting rights, there is ample evidence that giving
Creation for U.S. Companies, focuses explicitly on
select shareholders control, that is far out of line with
long-term value creation and states as core Corporate their ownership stakes, reduces company value. Such
Governance Principle 2 that "shareholders should
structures reduce oversight by, and accountability
be entitled to voting rights in proportion to their
to, the actual majority owners of the company. They
economic interest." Proxy advisory firm, Institutional hamper the ability of boards of directors to execute
Shareholder Services Inc., has also voiced strong
their fiduciary duties to shareholders. And they can
opposition to dual-class structures.
incentivize managers to act in their own interests,
instead of acting in the interest of the company's
The Snap IPO in particular has elicited investors'
owners. Hollinger International, a large international
rebuke. After Snap announced its intended issuance
newspaper publisher now known as Sun-Times
of non-voting stock, CII sent a letter to Snap's
Media Group, is a striking example. Although
executives, co-signed by 18 institutional investors,
former CEO, Conrad Black, owned just 30% of
urging them to abandon their plan to "deny outside the firm's equity, he controlled all of the company's
Class B shares, giving him an
voice in the company."
overwhelming 73% of the voting
The letter noted that
power. He filled the board with
a single-class voting
friends, then used the company
structure "is associated
for personal ends, siphoning
with stronger long-
off company funds through a
variety of fees and dividends.
Restrained by the dual-class
stock structure, Hollinger
to owners," and that
stockholders at-large were
when CII was formed
essentially powerless to reign
over thirty years
If the only solution is for investors to abandon in such actions. Ultimately,
ago, "the very first
certain investments after dual-class systems have the public also paid the price
policy adopted was the principle of one share, one vote." Anne Simpson, Investment
done their damage, owners lose out financially and discussions in corporate boardrooms and C-suites across the country will suffer from a lack
of diversity, perspective, and accountability.
for the mismanagement, footing the bill to incarcerate Black for over three years after he was convicted of fraud.
Director at CalPERS,
This is a classic example of
has strongly criticized Snap's non-voting share model, dual-class shares leading to misalignment between
stating: "Ceding power without accountability is very management's actions and most owners' interests.
troubling. I think you have to relabel this junk equity.
Buyer beware." Investors have also called for stock
The typical retort from proponents of dual-class
index providers to bar Snap's shares from becoming
structures is that depriving most investors of equal
part of major indices due to its non-voting shares.
voting rights allows managers the leeway to make
By keeping index fund investors' cash out of such
forward-thinking decisions that cause short-term
companies' stock, such efforts could help provide
pain for overall long-term gain. This assertion,
concrete penalties for companies seeking to go to
however, ignores that many investors and in
market with non-voting shares.
particular public pension funds and other long-term
institutional investors are themselves focused on
There are many compelling reasons why institutional long-term gains. If managers have good ideas for
investors strongly oppose dual-class stock structures
long-term investments, such prominent investors will
that separate voting rights from cash-flow rights. In
likely support them.
Academic studies also reveal that dual-class structures underperform the market and have weaker corporate governance structures. For instance, a 2012 study funded by the Investor Responsibility Research Center Institute, and conducted by Institutional Shareholder Services Inc., found that controlled firms with multiclass capital structures not only underperform financially, but also have more material weaknesses in accounting controls and are riskier in terms of volatility. The study concluded that multi-class firms underperformed even other controlled companies, noting that the average 10-year shareholder return for controlled companies with multi-class structures was 7.52%, compared to 9.76% for non-controlled companies, and 14.26% for controlled companies with a single share class. A follow-up 2016 study reaffirmed these findings, noting that multi-class companies have weaker corporate governance and higher CEO pay. As IRCC Institute Executive Director Jon Lukomnik summarized, multi-class companies are "built for comfort, not performance." Proponents of dual-class structures also argue that investors who prize voting power can simply take the "Wall Street Walk," selling shares of companies that resemble dictatorships while retaining shares of companies with a more democratic voting structure. That is often easier said than done. For instance, passively managed funds may not be able to simply sell individual companies' stock at will. Structural safeguards such as equal voting rights should ensure investors' ability to guide and correct management productively as events unfold. If the only solution is for investors to abandon certain investments after dualclass systems have done their damage, owners lose out financially and discussions in corporate boardrooms and C-suites across the country will suffer from a lack of diversity, perspective, and accountability.
monitoring function can be exported to third parties, including the courts and government regulators. Regulators may need to step up disclosure provisions to ensure transparency of such controlled companies, and courts may be called upon to remedy the behavior of unchecked executives. In the monitoring and in the clean-up, the externalities placed upon outsiders make corporate voting rights an issue of public policy.
As the trend of issuing dual-class or multi-class stock continues, institutional investors should remain vigilant to protect shareholders' voting rights. PreIPO investors can oppose the issuance of non-voting shares during IPOs. Investors in publicly traded companies can speak out against proposed changes to share structures or resort to litigation when necessary, such as in the Google, Facebook, and IAC cases. Institutional investors may also lobby Congress, regulators, and the national exchanges to revive the traditional ban on non-voting shares or make it harder to issue no-vote shares. For instance, in the wake of the Snap IPO, CII Executive Director Ken Bertsch and other investors met with the SEC Investor Advisory Committee. They encouraged the SEC to work with U.S.-based exchanges to (1) bar future no-vote share classes; (2) require sunset provisions for differential common stock voting rights; and (3) consider enhanced board requirements for dual-class companies in order to discourage rubber-stamp boards. Whether by working with regulators, securities exchanges, index providers, or corporate boards, institutional investors that continue to fight for shareholder voting rights will be working to promote open and responsive capital markets, and the long-term value creation that comes with them.
Blair A. Nicholas is a senior and managing partner and Brandon Marsh is a senior counsel at Bernstein Litowitz Berger & Grossmann in San Diego.
Ultimately, arguments regarding investor choice also ignore that failures in corporate governance can impose costs not only on corporate shareholders, but also on society at large. When dual-class stock structures prevent boards and individual shareholders from effectively monitoring corporate executives, that
ENDNOTE 1Our firm, Bernstein Litowitz Berger & Grossmann, represents CalPERS in this litigation.