The Dual Share Duel (Corporate Counsel)
Lizanne Thomas, head of the Jones Day corporate governance team, explains why the campaign against securities with differentiated voting power is worse than wrong.
The recently withdrawn public offering for WeWork (leaving aside its other complications) has resuscitated an argument in some quarters about the propriety of dual-class stocks. The company’s proposed securities structure would have given its founders voting power outsized compared to their actual financial stake.
Lyft’s recent offering involved similar unevenness. The ridesharing behemoth debuted with a structure that gave its two founders 10 votes for every share, resulting in 50% voting control of a company in which their economic ownership is closer to 5%.
Such differentials have become increasingly common for tech company listings. And they draw the ire of certain observers, who decry what they perceive to be second-class ownership for common shareholders. Critics also complain that the framework makes it difficult to remove owners if an organization’s performance plummets.
It is time to sprinkle water on those with their hair on fire. For starters, dual-share structures stretch back—at least—to 1925, when Dodge Brothers Inc., which was then owned by Dillon, Read & Co., issued nonvoting stock. Investors gobbled up those shares. Such arrangements also have been a common practice among family owned firms and some employee-owned firms, which have gone public with a lesser voting class of shares that have not drawn widespread umbrage.
Critics of dual-class stock ignore the protection that it can afford companies against irresponsible attacks from activist investors. In parallel, proponents can point to evidence that unequal voting generally strengthens long-term corporate thinking. Indeed, since shares carrying more powerful voting rights typically are not allowed to be traded, this ensconces investors who are likely to remain true blue even during rough patches.
More to the point, under securities law, the requisite transparency of any such offering means that investors are well-informed. So they are free to choose. If they don’t want to buy nonvoting or lesser-voting securities, they don’t have to. This all places the burden of proof on those who would interfere with a marketplace that is running with openness and efficiency.
Take a look at the disclosures by dual-class companies. No one can be misled about the consequences of buying into such arrangements. And that is all our securities law should do—require companies to tell the truth, and let the market speak.
The empirical literature on performance differentials between unequal voting stocks and the rest of the market is somewhat mixed. But it is instructive that MSCI Inc., indexer of roughly $14 trillion, last year concluded an 18-month examination of whether to remove dual-class firms from their listings by rebuffing the banning brigades. An analysis by the indexer found that the returns for enterprises with unequal share structures exceeded the overall market between November 2007 and August 2017. (MSCI can be subject to some justifiable criticisms, but that pertains to its evaluating and grading of companies on subjective scores, not its data-based green-eyeshade work.)
The authors of another study, published in Harvard Business Review, see positive virtues in a dual structure because it “enables founder-managers to ignore pressures from the capital markets and avoid myopic actions such as cutting research and development and delaying corporate restructuring.” Banning such shares, they argue, would actually be counterproductive. The interdiction would only incentivize technology companies to go private if they are publicly listed and stay private if they are not. Now, that would be deleterious to rank-and-file investors.
Take Facebook, which has been one of the biggest recent targets for tech bashers. CEO Mark Zuckerberg owns roughly 14% of the company that he founded, while his special class of shares means that he controls 60% of the voting rights. But whatever the merits or flaws in the critiques about the company’s behavior, its structure has certainly not hurt its share price: That figure has increased from $38 at the time of its initial public offering in 2012 to $180 as of mid-August, markedly outpacing the S&P 500.
The performance of Google’s parent company, Alphabet, also refutes the classism critique. Its nonvoting class trades within 1% of its voting shares. Investors, in other words, discern little difference in value. In sum, those who put their money behind a particular organization are wont to accept differential classes of securities if the enterprise in question displays promising expectations.
Another danger that comes from the dual class opponents is that mandatory bans or sunset provisions, which they espouse, would unilaterally disarm certain companies in global competition. Chinese companies that are listed on U.S. exchanges don’t offer any such remedies. American companies already suffer competitive disadvantages against them in many instances, and bans on dual-class structures would only threaten to worsen that asymmetry.
Indeed, unequal voting structures are not at all uncommon in Europe. And in Asia, the Hong Kong and Singapore exchanges, which had long banned such listings, recently revoked those proscriptions.
The current furor comes in the context of the burgeoning techlash. The leaders of that movement delight in attacking Silicon Valley’s unicorns—which includes arguments that dual offerings constitute some sort of new and insidious challenge to established and proper investment norms. They might go ask holders of Class A shares in Berkshire Hathaway how that’s worked out during the past half century.
We have been generally well served since The Great Depression by the securities regulations that were passed during that time. Another lesson of that era is also apposite. Prohibition does not work—efficient markets do.
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