Corporate Dual Class Share Structures

A dual class share structure is used in certain corporations where one or more classes are given all or a bulk of the voting rights and another class or class has the same economic interest in the company, but none of the voting rights.   There can also be other rights that are given to one class instead of the other.  This type of structure is used so that the existing Board of Directors and management of the corporation maintain their control of the company.  It bcaeme common in news organizations (think the Economist Group, or the News Corporation a la Rupert Murdoch) so that the company could ostensibly keep its journalistic integrity and credibility or to stay true to its goals, without pesky shareholders muddying the waters.

A dual class share structure can serve desirable goals, such as shielding management and the board from short term views of dissident shareholders/analysts and hostile takeovers.  This can be helpful, as the constant quarterly pressure to meet revenue expectations is a burden on many companies at the expense of long term sustainable growth.  Management at companies with dual class structures argue that if shareholders aren’t happy with the structure, they are free to sell their shares and walk away.  Not surprisingly, only companies that are rather a hot commodity in the market can really get away with using this structure.

A percieved downside to this type of structure is that it allows management to dismiss the wishes of shareholders, and it allows the Board and managment to become entrenched.  Shareholder advocates say that this can lead to wasteful behaviour (i.e. value destruction) by Boards and management, essentially minmizing returns.  There are theories that conclude that companies with dual class structures trade at a discount to companies with traditional share structures.  Recent studies have shown that companies with dual class structures did perform worse in the market than those companies with equal voting rights for all shareholders.  The studies were performed by Paul Gompers, Joy Ishii and Andrew Metrick, but they only looked at the years from 1994 to 2002.

In the last couple of years there has been a rash of IPOs of companies with dual class structures lately.  This year, notable IPOs included Facebook, Inc., Manchester United, Ltd., and  Oaktree Capital Group.   These are all following the lead of Google, which IPO’d with dual shares in 2004.  Many other high-tech companies since then have adoped this structure (see LinkedIn in 2011 and Zynga and Groupon this year).

Recently however, the largest “investor” in the United States ($247B under management), the California Public Employees’ Retirement System (“Calpers”) announced that it would develop governance criteria that would attempt to prevent any investment in a company with a dual class stock structure,  or classified or plurality voting structures.  There has been scholarly debates on the effect this action from Calpers may have.

Just like gravity works, other investors may take the cue from Calpers, the largest.  This may be a recurring theme. If the pension funds and other large players in the investment community cannot create enough of a disincentive for companies to have the dual classes, however, then perhaps the goverment will come up with something.  The President, Senate and even the SEC have been pushing for increased shareholder access to companies, whether it be through proxy access or other means.

To be honest, most management teams would prefer to have a dual class structure.  It keeps decision making where they want it (with them), and that is not always a bad thing.  We’ll see where this ends up.