Dual Class Stock: Background and Policy Debate

Dual Class Stock: Background and Policy Debate

December 8, 2021
Dual Class Stock: Background and Policy Debate
When investors acquire the common stock of publicly
visions unbothered by shorter-term pressures such as the
traded companies, that share ownership generally entitles a
vagaries of the stock market, unsolicited acquisition
shareholder to two things: (1) a financial stake in the firm
attempts, and the demands of activist shareholders.
and (2) the right to vote at annual and special company
meetings on such things as candidates for the board of
Critics include the Securities and Exchange Commission
directors, potential corporate acquisitions and mergers,
(SEC) Investor Advisory Commission and Investor
management proposals, and non-binding shareholder
Advocate, the Investor Stewardship Group (a group of U.S.
proposals aimed at changing company policy. Overall,
and global institutional investors and asset managers), and
about three-quarters of publicly traded U.S. firms
various academics. Principal criticisms are that (1) DCS
reportedly have shares with equal voting rights, popularly
subverts the widely embraced notion of shareholder equity,
known as “one share, one vote.” The remainder have
the idea that shareholders are entitled to equal voting power
common stock that have shares with differential voting
with respect to the individual shares that they own; and (2)
rights called multi-class stocks and dual class stock (DCS)
it can cause the rights, needs, and prerogatives of majority
in cases where there are two classes. Multi-class stocks and
shareholders to be subsumed by minority shareholders with
DCSs have raised concerns for some over the implications
superior voting shares, also known as the principal-agent
of the power disparity between founder-managers with
problem. The latter may manifest itself through insulated
superior voting shares and the majority shareholders with
and entrenched owner-managers more prone to engage in
inferior ones. The most common form of DCS involves one
wasteful or inefficient self-interested behavior, including
class of shares with 10 times the voting power of the other.
awarding excessive compensation, and pursuing vanity
Some firms, however, have issued shares with 20 times the
research and development projects; and imprudent
voting power of the other.
corporate acquisitions.
Few firms have share classes wherein one class has voting
History and Regulation
rights and other shares are non-voting. One of the most
The first American publicly traded firm to issue multi-class
controversial of this occurred in 2017 when an initial public
shares was reportedly the International Silver Company in
offering (IPO) by Snap, the parent company of Snapchat,
1898. Use of differential voting shares, however, did not
involved the issuance of three share classes, one with 10
really take off until the early 1920s. By the middle part of
votes per share, one with one vote per share, and one with
that decade, public outcry over DCS ensued after a stock
no votes.
issuance by the Dodge Brothers, an auto maker. Traded on
the New York Stock Exchange (NYSE), the firm’s minority
While controversial since the 1920s, DCS has witnessed
stakeholders’ 1.7% of the issued common stock gave them
renewed attention and seen revived controversy in the past
complete voting control over the majority shareholders’
couple of decades due to its heightened use by technology
non-voting shares. Widely seen as an unseemly disparity, it
firms. Such firms have included Google (the DCS tech
resulted in an uproar that prompted the exchange to issue a
pioneer in 2004, now Alphabet), Facebook, Snap, Dropbox,
de facto ban on DCS in 1926. Later, in 1940, the exchange
Lyft, Groupon, Fitbit, Kayak, Blue Apron, Zoom Video,
adopted a rule that, with few exceptions, barred listed firms
Roku, Chewy, and TripAdvisor. According to some
from issuing non-voting stock and prohibited superior-
reporting, in a given recent year, nearly half of tech IPOs
voting stock from constituting more than 18.5% of all
have involved multi-class shares. Non-tech firms with DCS
outstanding common shares. According to various sources,
include Coca-Cola, the Ford Motor Company, Nike, Levi
these effectively limited most multi-class NYSE listings.
Strauss and Company, and the Hyatt Hotels. A host of
media firms have also employed DCS and include the New
In the early 1980s, the historically dominant NYSE faced
York Times, News Corp., CBS, Comcast, and Liberty
growing competition from the American Stock Exchange
Mutual.
(AMEX), which allowed DCS with some conditions, such
as allowing classes of stocks with no more than a 10-to-1
Proponents of DCS include NASDAQ, officials at various
voting ratio between them, and especially the NASDAQ,
companies, and some academics. Key supportive arguments
which had no DCS restrictions. Firms were also looking at
include (1) that it is a proper manifestation of private
DCS as a tool to help ward off unsolicited takeover
ordering, the idea that investors are free to invest in firms
attempts, which were on the increase. The NYSE had
with various types of capital and governance structures and
several firms that were threatening to delist from it if they
other attributes that meet their needs; and (2) that,
could not recapitalize with DCS. Subsequently, in 1986, the
particularly for tech firms, it allows entities who control a
exchange allowed recapitalization with multi-class stock.
firm (such as its founders and funding venture capital firms)
the latitude and time to pursue their often unique business
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Dual Class Stock: Background and Policy Debate
In 1988, to level the multi-class share playing field among
 An event-based sunset in which the uniform stock
the exchanges, the SEC adopted Rule 19c-4 of the
conversion is precipitated by the occurrence of a
Securities Act of 1934. The reform prohibited a firm from
designated event such as the founder’s disability, death,
being listed on a national exchange if it had taken actions
or attainment of a retirement age. The underlying
that had the effect of “nullifying, restricting or disparately
rationale is that firms benefit from the presence of
reducing the per share voting rights of existing” common
healthy founders whose ability to lead is bolstered by
stockholders. By various accounts, in doing so, the rule
their ownership of superior voting stock.
effectively banned most forms of DCS.
 A fixed-time-based sunset in which the conversion of
multi-class stock to uniform voting shares occurs at a
Soon afterwards, the Business Roundtable, a group of large
specified future date. An underlying premise
public company corporate executives, challenged the SEC
(supported by some research) is that while initially
rulemaking, arguing that shareholder voting rights was a
beneficial for a firm after an IPO, over time dual class
matter of state corporate law. Later, in Business Roundtable
structures lose their value to the company. Time-based
v. SEC, 905 F.2d 406 (D.C. Cir. 1990), in 1990, the Court
sunsets range from three to 20 years, with 10 and then
of Appeals for the District of Columbia nullified the SEC
seven years reportedly being the most common.
reform, ruling that the agency had exceeded its authority
Sunset provisions appear to be growing in popularity.
under the Securities and Exchanges Act of 1934.
While they remain relatively limited—the Council of
Institutional Investors (CII, a coalition of institutional
Subsequently, in 1994, the NYSE, NASDAQ, and the
investors) reported 41 by 2020—they have grown over
AMEX adopted similar policies that permitted their listed
time. For example, in 2018 then-SEC Commissioner Robert
firms initially to issue multi-class shares but does not allow
Jackson spoke about the absence of sunset provisions,
them to subsequently reduce the stock’s voting rights
observing that over the past 15 years, almost half of the
during recapitalizations. That regulatory regime still stands.
companies whose IPOs involved DCSs awarded corporate
insiders superior voting shares in perpetuity. CII, however,
In 2017, the aforementioned Snap IPO’s unorthodox
reports growing use of time-based sunsets. It found that
issuance of non-voting public stock was widely criticized.
while 26% of newly public dual class firms had such a
As part of the backlash from this, several entities, including
provision in 2017, 51% adopted it in the first half of 2021.
the SEC’s Investor Advisory Committee and the Council of
Institutional Investors, petitioned owners of major stock
The CII petitioned the NYSE and NASDAQ in 2018 to
indexes to exclude firms that issue DCS from the indexes.
require newly listed dual class firms to adopt a time-based
That same year, S&P Dow Jones announced that firms with
sunset provision. A critic of dual class firms, the CII argued
new dual class share offerings would be excluded from its
that “evolving market practice and academic research
S&P Composite 1500 and its various indices, including the
suggest[s] that multi-class structures become problematic
S&P 500. At the same time, FTSE Russell, a subsidiary of
within five to nine years.” (According to the CII, the mean
the London Stock Exchange, announced that firms with
time-based sunset in 2020 was 12 years.) It then said that a
dual class stock would be excluded from its stock indexes,
seven-year sunset was a good compromise vis-à-vis an
including the Russell 3000, if their majority-held shares had
outright ban.
less than 5% of the voting power of their superior shares.
Draft Sunset Legislation and Debate
A Look at the Value of Multi-Class Shares
There is currently draft legislation under committee
A fundamental question in the debate on multi-class
consideration aimed at encouraging DCS to include sunset
structures is what their value is to their firms. This is the
provisions. The draft bill would prohibit the listing of any
subject of considerable research. In 2021, Guerra-Martinez
security of an issuer with unequal voting classes of stock
examined much of that work and observed that the
for more than seven years without shareholder approval.
preponderance of research indicates that the value of firms
with multi-class shares diminishes over time. Saying that
Research on the effects of sunset provisions is mixed. In
more research is needed, the study noted that some research
2018, the staff of then-SEC Commissioner Jackson
has found that such firms can earn higher valuations at the
examined IPOs during the previous 15 years. They found
IPO stage and have a beneficial effect on innovation and the
that seven or more years away from an IPO, firms with
promotion of local industry. It also found that since 2014,
perpetual DCS traded at significant discounts compared to
the percentage of newly public tech firms with DCS has
those with sunset provisions. Related research (Bebchuk
been higher than non-tech DCS firms. It then questioned
and Kastiel, 2017) found that controllers of firms with DCS
whether the historical research on multi-class stocks has
have perverse incentives to retain them even after they
fully reflected what some describe as “the higher
result in inefficient firms. Alternatively, 2019 research by
idiosyncratic value [the value an entrepreneur places on her
Fisch and Solomon observed that (1) academic research on
ability to execute a business idea] probably created by
the implications of time-based sunsets is insufficiently
founders of tech firms.”
developed and (2) fixed-time sunsets are too arbitrary to
reasonably accommodate the variability among dual class
Sunset Provisions
firms and their life cycles. Gurrea-Martínez (2021) has
Various firms with multi-class shares have “sunset”
cautioned that a mandatory time-based sunset could
measures in their charters that provide for triggers that
dissuade some firms from going public. India is reportedly
result in all company common shares being converted into a
the only nation with a mandatory time-based DCS sunset.
single voting share class. The major kinds of triggers are:
Gary Shorter, Specialist in Financial Economics
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Dual Class Stock: Background and Policy Debate

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