Both practitioners and academics generally have a dim view of dual-class share structures. For example, when Snap Inc. was preparing for its initial public offering (IPO) in 2017, CalPERS and other institutional investors harshly criticised the company’s move to create a new share class with no voting power. In addition, FTSE Russell and S&P Dow Jones Indices recently decided to exclude some dual-class stocks from their indices.
The main drawback of a dual-class share structure is that insiders who control the firm with disproportionate voting rights relative to their cash flow rights can easily take advantage of dispersed outside shareholders. (Co-founders Bobby Murphy and Evan Spiegel, for example, jointly own 45 percent of Snap shares but control more than 70 percent of votes.) Essentially, this unequal voting power gives insiders incentives to collect perks or pursue projects that may not be in the best interest of other shareholders.
The usual mechanism for protecting against this type of exploitation is monitoring by the board of directors or other shareholders, which is difficult under a dual-class governance structure. Thus, at first glance, a dual-class structure seems like a ‘bad idea’.
Yet the IPOs of Google, Facebook, Alibaba, and other prominent companies, especially in the high-tech sector have adopted dual-class voting. This observation is what led us to look more closely at the potential benefits of that structure, particularly over firms’ life cycles. The key benefits of the structure are that it allows firms to focus on maximizing long-term value, without worrying about costly takeover defenses or delivering short-term profits. It also allows firms to benefit from the unique knowledge of insiders (eg, think about Alphabet’s Larry Page and Sergey Brin) without having to consider the less informed opinion of outsiders. Given that for young firms, outside investors are particularly less informed about the quality of investments, we argue that this protection from capital market pressure is especially beneficial for them. However, these benefits will decline as firms mature, growth slows, and the founders are no longer around or lose their unique advantage in leading the firm.
In our paper, ‘Sticking around Too Long? Dynamics of the Benefits of Dual-Class Voting’, we examine how the benefits of dual-class share structures, net of costs, evolve over a firm’s life. We carefully (often manually) construct a database of more than 900 unique dual-class firms in the United States over almost 50 years, from 1971 through 2015. Using the data, we show first that the voting premium for superior classes of shares is 3.8 percent higher for mature (ie, older than or equal to the 12-year median age of firms in the sample since their IPOs) dual-class firms than young ones. We interpret this finding as evidence that private benefits of control, an important cost of the structure to minority shareholders, increase over firm maturity.
This evidence may also suggest the net economic benefits of dual-class voting decline with maturity. We explore this hypothesis in several ways. First, we examine the market’s reaction, conditional on maturity, to the announcement of dual-class recapitalisations, in which a superior voting stock class is created, and dual-class stock unifications, in which multiple stock classes with different voting rights are unified to become one share–one vote. In both respects, the perceived value of a dual-class structure is about 5% lower for mature firms relative to young firms.
Second, we show that young dual-class firms have about 7% greater valuation relative to single-class firms of the same maturity, in the same industry, and with similar characteristics. However, as they mature, dual-class firms experience approximately 9% greater declines in valuation than do single-class firms. One implication is that dual-class firms do not seem to adjust their share structures optimally to changing circumstances over their lives. Further analyses find that deteriorating operating performance, pace of innovation, and increasing systematic risk are behind this declining effectiveness of the dual-class structure over time.
Overall, the evidence in our paper suggests that the costs of a dual-class share structure increase significantly when firms mature, while the benefits of shielding firms from capital market pressure appear to decrease. Our findings challenge the dominant view that dual-class voting is suboptimal. Rather, the voting structure is likely to be optimal for young, fast-growing firms. Thus, we argue that rather than precluding dual-class firms altogether, investors and firms are better off by permitting these structures but tying them to sunset provisions. Such provisions would set an event (such as passing of a fixed period of time) that automatically ends the structure, or give minority shareholders an optional vote determining an extension of the structure at a predetermined time post-IPO. These provisions are simple to understand and implement, and they achieve the goal of allowing firms and investors to enjoy the advantages of a dual-class structure when there are clear benefits of giving insiders and management more control, and of providing a time-consistent way to end this structure when ‘the time is up’.
Hyunseob Kim is Assistant Professor of Finance at Cornell University.
Roni Michaely is Professor of Finance at the Geneva Finance Research Institute, University of Geneva.