Industry view: Why dual-class share structures look like the ‘new normal’
Dual-class share structures became a hot-button topic in 2017 and debate continues into 2018. Although these structures have been around for many years in the US, Canada, Sweden, Denmark and the Netherlands, previously staunch opponents such as Singapore and Hong Kong have recently moved to allow them, and UK regulators have also discussed relaxing their rules. The normalization of this type of listing is having a material impact on how companies need to engage with not only investors but also the wider public.
The growth of big technology firms has been a game changer for global markets. When companies such as Alphabet, LinkedIn, Facebook and Alibaba went public, they picked the NYSE because at the time it was one of the true global exchanges that offered dual-class share structures. When the companies listed, their stock was split into different categories, known as dual-class shares, to give owners of one class greater voting rights than owners of the other. Crucially, that allows the company’s founders or leaders to retain control of their business.
In the case of Facebook and Alibaba, its founders have retained control over two of the world’s most valuable companies. With less than 1 percent of the social media firm’s publicly traded stock but 60 percent of its voting power, Mark Zuckerberg was able to drive through Facebook’s acquisition of WhatsApp for $22 bn with little shareholder input. Although many observers questioned the rationale behind paying so much for a business that was only generating $10 mn in revenue at the time, it was a decision that paid off and strengthened Facebook’s position as an integrated ‘technology lifestyle’ company.
Similarly, when Alibaba listed in September 2014, founder Jack Ma created a corporate structure that left him and his partners in control of the business, rather than shareholders. There is a strong appetite for dual-class shares in Asia, as the region sees the rapid explosion of big technology firms rivalling those of Silicon Valley – most of these Asian companies are family-run companies, whose founders want to preserve control to pass on to their sons and daughters.
The listing reforms in Hong Kong will allow these ‘new economy’ companies with dual-class shares to seek a primary listing in Hong Kong. It will also allow those with a market cap of more than HK$10 bn ($1.27 bn) to seek a secondary listing in Hong Kong as long as they have a primary listing on the NYSE, London Stock Exchange or Nasdaq.
Singapore Exchange has not been as prescriptive with its definition of the type of company that can list with this structure but plans to publish guidance on the topic in the next few months.
The main argument in favor of dual-class shares is that for such innovative companies, founders need to retain such an element of control to drive growth without feeling inhibited by short-term performance pressures. When the founder´s vision is value-creating, it can be in everybody’s interest to let him or her manage the corporation.
But if that is the case, why is there a backlash against the model? Snap’s IPO on the NYSE in March 2017 caused a stir when it offered only non-voting shares to investors. The company received considerable attention in the media, with many observers criticizing the corporate governance decision. In the months following, the S&P Dow Jones Indices opted to exclude all new dual-class share offerings from the S&P Composite 1500 (comprising the S&P 500, S&P MidCap 400 and S&P SmallCap 600) and the FTSE Russell barred companies from inclusion in its benchmark indexes unless more than 5 percent of the voting rights are in the hands of public shareholders.
But not all investors have reacted in favor of these moves by the indices. BlackRock, Vanguard and State Street Advisors – the biggest passive investors globally – have made it clear that while they support equal voting rights, they disagree with excluding the stock of certain public companies from indices. They believe this makes their index funds less representative of the investment universe they are trying to represent, thereby affecting returns for investors.
Martin Sorrell, the CEO of WPP, the world’s biggest advertising firm, has also defended dual-class structures, arguing that companies with dominant shareholders take more risks and tend to perform better. ‘Perhaps surprisingly, corporate structures that seem to offend customary good corporate governance may deliver better long-term results,’ he has said.
Navigating the ‘new normal’
With Hong Kong and Singapore having made the switch, and even London looking into dual-class options, the global grain has shifted: dual-class share offerings are becoming the new normal. We are even starting to see three-class share offerings, which is what Dropbox has just filed for.
Ultimately, companies looking to adopt a dual-class or three-class structure need to recognize that this is less about the debate surrounding whether the structure itself is right and more about whether this is the correct structure for their business, their shareholders and the wider public. And if it is the correct structure for them, they also need to explain why.
A dual-class structure is, in effect, asking shareholders of that business to place their trust in management and its judgment. Founders of companies need to be open and transparent about their vision for the company and the rationale behind the decisions they make, explaining how these are in the best interest of the company over the long-term.
Where Snap went wrong is that when it did finally offer an explanation – arguing that the structure would enable it to maximize its ability to create shareholder value, because a significant portion of its success had been due to the founders’ leadership – it did so behind closed doors to the Council of Institutional Investors instead of in the public domain where judgments were being made.
Sheena Shah is a director at Finsbury in Hong Kong