|Do Dual-Class Stocks Make for Second Class Shareholders?|
By Justin Sharon AUG 22, 2012 12:00 PM
Twenty dual-class IPOs occurred in the US last year, up from only a dozen in 2010. In the S&P 500, forty companies employ this structure.
Assigning various share classes that carry different voting, and in some cases dividend, rights has a long lineage on Wall Street.
The International Silver Company began the practice when it issued 11 million non-voting equities in 1898. The Roaring Twenties' market mania cemented the practice, although the crash with which that decade came to a shuddering close led to an eventual ban by the NYSE (NYX).
Dual-class shares have historically proven particularly popular with old-time media moguls, where a cadre of tightly knit family members often exerted an iron grip. Industry examples include the Ochs-Sulzberger trust of New York Times fame, the Washington Post (WPO) Grahams, the Bancroft family behind Dow Jones, and Time Mirror's Chandler clan. The preservation of journalistic integrity and prevention of undue outside editorial interference are the principal reasons cited for the prevalence of dual stocks in the newspaper arena.
Adolph Coors, Ford Motor Company (F), and Hyatt Hotels (H) are instances of equities in other sectors that have operated along similar lines over the years.
After lying dormant for decades, dual stocks enjoyed another of their periodic moments in the sun during the 1980s, when they were employed as a useful tool to rebuff the cutthroat corporate raiders of that era. Ironically on July 4, 1986 — the very day millions gathered in New York Harbor to celebrate the centenary of that ultimate testament to democracy, the Statue of Liberty — that morning's newspaper headlines told of the NYSE’s decision to do away with its time honored “one share, one vote” rule. Eventually individual exchanges again tightened their rules but, crucially in light of future developments, agreed to allow a company to go public if its dual class structure was already in effect at the time of the IPO.
Dual-class arrangements, while remaining relatively common in Europe, thus waned once again in the United States. That is, until Google's (GOOG) gigantic IPO eight years ago ignited the current frenzy. The Internet search outfit went public with a format that allowed co-founders Sergey Brin and Larry Page to oversee two-thirds of total voting authority, an approach Buffett himself said made him "very pleased." Two years later, the firm survived a proposal by the Bricklayers & Trowel Trades International Pension Fund to do away with duals. At a contentious annual meeting, union member John McIntyre worried aloud about "the potential inbreeding of ideas that can be engendered by [such a system]."
Doubling down on its policy, this year Google announced that it would issue a third class of stock, "C" shares devoid of any voting rights whatsoever. Amid concerns that Moscow-born Brin was assembling the sort of centralized power of which President Putin would be proud, Forbes denounced its "paranoid structure," and the Financial Times labeled the latest stock offering "a new low in corporate governance."
The company whose motto is "Don't be evil" may have an inner sanctum that looks a lot like a Palo Alto politburo these days, but shares stand at their highest level since January 2008, so who's to argue? Anyone who took the trouble to read the pertinent line from Google's IPO filing -- "New investors will fully share in [our] economic future but will have little ability to influence...strategic decisions through their voting rights" -- can hardly claim to have been mislead on either count.
There have been instances of organizations choosing to abandon their dual-class format and opt instead for unification.
Citing its desire to reduce "the appearance of being a closely-held company, [and] the expenses and confusion associated with maintaining two separate classes," the board of GameStop (GME) swapped each class "B" share for .32 of an "A" in 2007.
Readers Digest, which has subsequently slid into bankruptcy, belatedly abandoned family control a decade ago while JM Smucker (SJM) has had a happier time of it since unifying in 2000; its shares are trading to a new historic peak just this week. And despite the almost utter dominance of the New York Times' Sulzberger Trust – which parlays a scant 0.6% equity ownership into over 90% of voting rights -- even the venerable Gray Lady has occasionally demonstrated an ability to change her ways.
In 2008, the newspaper agreed under duress to allow outside funds a modicum of decision-making representation. Even so, shareholders who have seen approximately 80% of their value vanish over the past decade continue to have little recourse, with the current configuration only overturnable in the extremely unlikely event that six of its eight board members acquiesce.
Supporters of dual-stock structures attest that the format allows a firm's founders, who did after all often build the empire in question from scratch, to focus on the long term, free from the institutional interference and day-to-day distractions of the stock market.
Critics call them an increasingly dangerous form of corporate governance, resulting in crony capitalism where control-freak CEOs are only too happy to accept capital, but remain unwilling to relinquish any authority. Thwarted by boards stacked with yes-men, shareholders in this scenario find it almost impossible to hold management adequately accountable for failure. Academic research is available to support both contentions, but recent studies have demonstrated that duals tend to underperform their single class peers, often also being burdened by greater levels of debt.
Ending as we began with The Wall Street Journal, the newspaper’s lead item on Monday announced “Groupon Investors Give Up.” Among those rushing to offload the slumping stock, the article referenced Silicon Valley icon and Netscape founder Mark Andreessen, whose venture capital company jettisoned some 5.1 million shares at the earliest opportunity. The same Mr. Andreessen who attested not long ago: "It is unsafe to go public today without a dual-class share structure," adding, "I feel better if another investor can't topple [a company founder]."
On Wall Street, as elsewhere, it often quite literally pays not to listen to what people say, but instead watch what they do.