Dual-class share structures are making a comeback

By Dr. Al Rosen, Mark Rosen | September 18, 2015 | Last updated on September 18, 2015
4 min read

Even though dual-class share structures have been long reviled by corporate governance pundits who live by the mantra “one share, one vote,” the structures are regaining popularity, driven in part by high-profile examples of superior stock performance.

Aside from capping foreign ownership (e.g., in telecom and airlines), dual-class share structures exist to provide one group (usually company founders) with voting control over the direction of the company. That can be done through super-voting shares, where one share of equity has multiple votes, or with non- voting shares for the majority.

During the height of the revolt against these structures in Canada a decade ago, the TSX revamped its ticker symbols, hoping investors could identify stocks with inferior voting rights. Problem was, everybody strained to recall tickers like TEK.SV.B (the symbol for one class of Teck Cominco shares), or to make the distinction between multiple, subordinate, limited, restricted and non-voting shares. The new tickers were abandoned not long after.

It was never clear why some corporate governance pundits thought plain disclosure wasn’t sufficient warning for investors, or why they believed company founders should surrender the economic value of their voting control for free. After all, investors can vote with their feet at any time. In truth, it seemed the biggest complaints always came from activist investors or institutions with large illiquid ownership interests who were facing buyer’s regret.

Luckily, times have changed. Advisors need to be aware that dual-class shares are enjoying a rebirth. Several recent Canadian IPOs have sported dual-share structures, including Cara Operations, Shopify and Spin Master.

Successful companies

At least some of the resurgence in dual-class structures is due to the success that many companies and investors in the U.S. have enjoyed, especially in the tech realm. Google Inc. (soon to trade as Alphabet Inc.), with a market cap of roughly US$450 billion, has had a dual-class structure since its IPO in 2004. The stock has also appreciated at an annual rate of 29% per year since. Founders Larry Page and Sergey Brin control the company through super-voting shares, which outweigh the combined power of the regular-voting and non-voting listed shares.

While being a cash machine doesn’t hurt in convincing the market that the founders should have sole control of the reins, Google has also remained responsive to market input. In August 2015, the company announced a corporate restructuring that will provide greater financial statement transparency, which is almost always better for stock performance.

Google is far from alone. Facebook has risen 32% annually since its IPO in May 2012. Founder Mark Zuckerberg controls the company with 55% of the votes while owning just 20% of the company.

Then there is Warren Buffett, who has defended dual-class shares, not only at his holding company, Berkshire Hathaway, but also at several public companies in which he has invested.

Despite these successes, proxy advisory firms still routinely urge investors to vote in favour of proposals that ask founders to surrender the value of their superior voting shares with no compensation. Generally, listed shares with superior votes trade at a 2% to 6% premium to their inferior counterparts. The value of complete control is usually much greater than that.

The flipside of dual-class shares

The blanket corporate governance stance of the advisory firms is somewhat understandable. For every Google or Facebook, there seems to be a Magna or Bombardier.

Magna famously paid Frank Stronach $1 billion to collapse the dual-share structure at the auto-parts maker in 2010. Stronach held two-thirds of the votes with less than 1% equity. As bitter a pill as it was for investors to swallow, the shares are up 300% since the deal was announced. Recently, the dual-class structure at Bombardier has been thrust back into the spotlight.

The share price is down 60% year-to-date as of mid-August. The stock enjoyed a brief respite when the market thought the company might sell off its rail assets for a handsome sum. But the company poured cold water on the idea, preferring to seek alternative funding arrangements and a long-term investment in the rail business.

Time will tell whether the company needs a firm hand on the rudder with a long-term vision, or whether investors would be better off with a large, one-time transaction to significantly boost shareholder value in the short term.

Hard to let go

The general reason for providing founders with voting control is to allow them to fulfill their long-term vision for the company while still accessing the broad funding of the public markets.

But even after 10 years as a public company, Google’s founders won’t let go. Also, they restructured the share classes in 2014 to allow the company to issue only non-voting shares in the future, potentially entrenching the founders’ voting majority for good.

The founders of Alimentation Couche-Tard are following a similar path. Originally, the retired executives, including chairman Alain Bouchard, were set to collapse their super voting control in 2021. Recently, they’ve asked shareholders to extend that control in a vote set for September 2015. That might not be a bad idea. It’s questionable whether Couche-Tard’s highly successful and transformative purchases, like SFR in 2012, would’ve been constrained under the quarterly watch of impatient shareholders.

Don’t like it? Leave

There’s nothing wrong with surrendering voting rights, as long as investors have faith in the founders’ long-term vision. If that faith wavers, investors can always vote with their feet, sell their shares, and leave the complaining to activist investors and corporate governance pundits.

by Dr. Al Rosen, FCA, FCMA, FCPA, CFE, CIP and Mark Rosen, MBA, CFA, CFE, who run Accountability Research Corp., providing independent equity research to investment advisors across Canada. www.accountabilityresearch.com

Dr. Al Rosen, Mark Rosen