Do Dual-Class Stocks Make for Second Class Shareholders?
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.
Also in February, the New York Times (NYT) informed its readers that controversy over an identical arrangement had made it all the way to the White House. The Times' story actually occurred 86 years earlier, which was a salient reminder that, in high finance, there is nothing new under the sun and investor indignation tends to run in cycles. The reliably Republican Journal and liberal leaning Times rarely ever find themselves on the same page, but both can speak with some authority on this issue. After all, each employ dual-stock structures themselves, the Journal under the umbrella of its corporate owner News Corp (NWS).
Had Facebook's IPO been the raging success many expected, its quirk of corporate governance would likely have remained a minor news item. The stock has instead been a famous flop, falling to a fresh low this week after dropping 13% last week, and it is the S&P 500's (^GSPC) single poorest performer in the three months since coming to market.
Investors can't claim they were caught unawares on the dual-stock provision. Indeed, when originally adopting the set-up in November 2009, Facebook explicitly said it was doing so "because existing shareholders wanted to maintain control over voting on certain issues."
By creating a second class of Class "B" stock, each carrying ten votes, founder Mark Zuckerberg manages to command almost 60% of the company's voting power while owning well under 30% of its equity. In fact, his authority is so absolute that it even extends to the afterlife, likely a long way off for someone born only in 1984. (1984 author George Orwell could have been addressing dual-stock formats when he warned that, while everyone is ostensibly equal, some are clearly "more equal than others.")
In high tech, imitation is often the sincerest form of flattery and others in the space that employ duals include Yelp Inc. (YELP) -- down 16.8% last week -- and Groupon (GRPN), off 36% to its lowest level ever in the same period. Groupon's founders, who cashed out nearly $1 billion in stock before the company's IPO, own 100% of the Class "B" shares and thus a clear majority of voting rights. Again, its intentions were made crystal clear at the outset. "This concentrated control will limit your ability to influence corporate matters and, as a result, we may take actions that our stockholders do not view as beneficial," the company wrote in its annual SEC report. Still, disgruntled investors unable to evict a CEO seen swilling beer while accounting restatements were raging on his watch will likely find this heads-up cold comfort.
Other peers with similar structures are LinkedIn (LNKD) and Zynga (ZNGA), which went one better with its three-tier configuration in which CEO Mark Pincus owns all Class "C" common shares carrying 70 votes apiece.
Far from Silicon Valley, the soccer fields of England also supply eloquent testimony to the current dual-stock mania. Manchester United (MANU) went public earlier this month in the largest post-Facebook IPO. Once more, the offering allowed its owners, Florida's Glazer family, to keep control via a 10:1 super-voting share class. Dissent directed at the clan from local fútbol fans likely has more to do with the under-performing team, which kicked off its English season with a defeat on Monday, than the machinations of stock markets an ocean away. Investors, however, who quickly saw their stock drop below its IPO price of $14 will be more concerned about losing money than matches.
Currently just under 40 S&P 500 firms, accounting for approximately 8% of overall market capitalization, employ this structure. Yet with Wall Street famous for its "trend-is-your-friend" ethos, many find the increasing tendency to opt for it troubling.
Twenty dual-class IPOs occurred in the US last year, up from only a dozen in 2010. And octogenarians, not just hooded Harvard wiz kids, are among the most prolific practitioners.
At Viacom (VIA), Sumner Redstone, now in his 90th year, owns only about 10% of the company, yet oversees almost 80% of its votes. Warren Buffett's Berkshire Hathaway (BRK-B), where "B" shares confer just 1/200th of overall voting authority, and Rupert Murdoch of News Corp, each aged 81, are mere whippersnappers by comparison, but in recent years the investment community has also had reason to curse the relative lack of accountability at both of their dual-stock empires.
The fleeting front page scandal of Buffett's heir apparent may have been small potatoes compared with the phone hacking of a murdered schoolgirl that occurred under Murdoch's leadership, but the thorny issues of succession and potential corruptibility of absolute power highlighted by both are unquestionably harder to address under the current setup. News Corp's Class "A" shares account for roughly 70% of market cap, yet fail to provide the stakeholder a single vote. It's only the minority "B"s, heavily controlled by Mr. Murdoch himself, that grant this power. In October 2007, News Corp shareholders did decide against a proposal to abandon the two tier system by a hefty 77%-23% margin. This was, however, well before the News of the World tabloid debacle broke, and it should also be noted that deputy head James Murdoch would have been booted from the board last year without his father's votes. Such scenarios don't sit well with corporate purists, although both Berkshire -- a singularly brilliant performer since the 1960s -- and News Corp -- whose shares have recently traded at their highest level in almost half a decade -- can claim to have made many critics cry all the way to the bank.
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.
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