I was interested to read this article in the FT today. It reports that the Hong Kong stock exchange is once more contemplating whether to permit listed companies to have dual class share structures. The exchange has considered this topic several times previously and has historically rejected it and not permitted such structures. In the UK, there isn’t an absolute ban but the practice is deprecated and very few companies have such structures, Schroders (SDR/SDRC) being a notable exception. OTOH in New York and also in Europe such structures are not uncommon and have been adopted by several recent tech listings, Facebook being one example. The article also reports that the topic is being debated in London too, so it is relevant to investors primarily focused on the UK as well.
What is a dual class share structure? It is a corporate structure where there are two types or “classes” of shares: one with voting rights and the other without (or with diminished rights). What is the purpose of such a structure? Frequently it offers a mechanism whereby founders can retain control of “their” company whilst making a majority of the share capital available to outsiders. An argument used in favour of this is that outside shareholders are not just buying shares in a company but also backing the founder (Mark Zuckerberg in the case of Facebook) and that it is to everyone’s benefit for that eminent founder to retain control.
Personally, I don’t buy that argument at all. This is very similar to the debate concerning the separation of CEO and chairman roles. Some argue (and this is not uncommon in AIM companies) that the roles can be combined, particularly where a founder fills those roles. This argument, however, was settled long ago and separation of those roles is enshrined in the UK Corporate Governance Code wherein it was concluded that best practice was to separate those roles and have a non-executive chairman distinct from the CEO and a majority of independent non-executives on the board. The primary issue is that it is too dangerous to have one individual holding all the levers of corporate power, without any independent oversight – and ShareSoc warns its members to be careful of investing in companies not compliant with this aspect of the Code. This conclusion flowed from the Cadbury Report, following a series of scandals at Coloroll, Polly Peck and Mirror Group.
By diminishing voting rights, shareholder democracy is compromised and management have free rein to do what they see fit – which may or may not be in shareholders’ best interests. In addition it offers a way for founders to “have their cake and eat it” (i.e. sell the majority of the company but still expect to be able to act as if they were the sole owners). That seems to me to be intrinsically wrong. I therefore feel that ShareSoc should oppose any moves to introduce dual class share structures in the UK.
Some Hong Kongers seem to be arguing that disallowing dual class share structures puts their exchange (and the UK and Singapore) at a competitive disadvantage vis a vis New York. I do not believe the UK and the LSE should participate in a regulatory “race to the bottom”, and that investors’ interests should be put first, not exchanges’ self-interest.
What do you think? [please add your comments below]
Makes sense, Mark.
Question 1 for me is whether they should be in the index. I think companies with dual class shares should not be in the index. If a company is in the index then all the index funds have to buy the share. There is then no pressure on good corporate governance.
Question 2 is whether I as an investor should buy their shares. This is a grown ups decision! I know the risks and I can make up my mind. Based on past experience, I would tend to avoid companies with dual class shares. According to Stockopedia ” Academic research offers strong evidence that dual-class share structures hinder corporate performance. A Wharton School and Harvard Business School study shows that while large ownership stakes in managers’ hands tend to improve corporate performance, heavy voting control by insiders weakens it. Shareholders with super-voting rights are reluctant to raise cash by selling additional shares–that could dilute these shareholders’ influence. The study also shows that dual-class companies tend to be burdened with more debt than single-class companies. Even worse, dual-class stocks tend to under-perform the stock market.” However, LSE could find no difference in performance of family owned businesses, but did note they tended to be less highly leveraged, see https://londoneconomics.co.uk/wp-content/uploads/2011/09/101-Comparing-the-economic-performance-of-family-businesses-and-non-family-businesses.pdf .
Another point is that such shares, with less than perfect corporate governance, should be clearly identified so that investors and potential investors know and get reminded from time to time that the corporate governance may not be good. A Main Market Premium listing should be the gold standard. Companies with dual class shares should have a big star against them. AIM companies, which do not have to meet the corporate governance requirements of the Main Market should also be clearly identified as such. Et cetera.
The trouble with loosening regulation, as implied by your response to Q2, is that companies are encouraged to take advantage of the laxer rules, as has happened in the US. I don’t think that is a desirable outcome.
I hold SDRC and from a practical pov it’s an advantage, it trades at a discount so I get a higher yield and if the shares are ever enfranchised I’ll get a windfall gain. Whether it would be a good idea for newly floated companies may be a different matter – you have an obvious example in Uber to say that founder control may not be a good thing.