Dual Class: Call for Views

The debate over the merits of dual class shares— and differential ownership more generally— continues to wage on, notwithstanding a wave of more permissive regulation in many key markets around the world. Even the UK, often seen as a global benchmark in governance standards and regulatory best practice, is moving in the direction of allowing for dual-class share structures in its highest listing segment. The UK had been one of the leading ‘holdouts’ restricting dual class share issuance, while recent regulatory changes in both Hong Kong and Singapore allowed for dual class issuance. Differential ownership structures (including loyalty shares) also feature commonly in large EU economies, notably in the Nordics, France, Italy and Spain.

The motivations to relax rules for dual class issuance reflect legitimate competitive concerns from local exchanges about losing listings to markets that allow for such share structures. In particular, there is the FOMO effect (fear of missing out) on losing the listing of potential ‘unicorns’, to the US market, particularly in the tech sector, where dual class structures are popular.

The attractions of dual class share structures to young companies, particularly in an IPO stage are clear and understandable. They provide a buffer to protect visionary entrepreneurs from the potentially short-term animal spirits of the financial markets, to allow the firm to blossom— and to ward off would be hostile takeovers while a company is still in development stage. We also have positive case studies like the Wallenberg group in Sweden which show how dual class share structures (within the context of a foundation ownership structure) can contribute to long-term stability and pursuit of a legitimate corporate purpose, both at a micro and macro (country) level.

So what’s not to like? These recent regulatory trends show that the dual class advocates have certainly been successful in allowing for greater acceptance of dual class shares. But have they won the argument?

The institutional investor community is not necessarily convinced.  Some have labelled this a regulatory ‘race to the bottom’, in which the (for profit) stock exchanges trade off or compromise shareholder rights to make their exchange competitively more attractive to issuers. Dual class shares ultimately marginalise minority investor rights and diminish the accountability of executive managers to shareholders. Investor generally view this as bad corporate governance.

At a time in which regulators around the world are introducing stewardship codes to encourage investors to play a greater, and more responsible, role in monitoring company governance, engaging and informed voting, the imposition of differential ownership rights has the effect of watering down investor influence in a way that is anathema to the goals of investor stewardship. The investor body ICGN has publicly described this phenomenon as “regulatory schizophrenia”.

Earlier in 2023 the Investor Coalition for Equal Votes (ICEV) was formed, including the US investor association, the Council of Institutional Investors, and several prominent US and UK pension funds, all of whom oppose dual class share structures. When Institutional Shareholder Services, the voting advisory firm, asked American investors in 2021, 94% favored a harder line on poor governance structures such as unequal voting rights. A similar investigation in continental Europe the following year gained 75 percent support. They have accordingly introduced policies to vote against directors of such companies.

Many investors acknowledge the potential benefits of a dual class structure in the initial years of a public company’s life.  However, they also recognise that as the life cycle of the company evolves the benefits of a dual class structure may erode over time and have the more negative effect of entrenching management and diminishing external accountability.  This is why the ICEV wants to encourage pre-IPO companies considering dual class structures to introduce reasonable sunset clauses.

As seen in ECGI working papers and other academic literature, there is mixed evidence on the pros and cons of dual class structures. In light of this there may be dual class advocates, dual class antagonists, and also dual class agnostics– those who value market forces and private ordering to shape a company’s bespoke ownership structure. 

With these regulatory changes has the train left the station with regard to the dual class debate? Or do there remain open issues or further chapters in this saga? Some open questions may include the following:

• Are there new empirical studies helping us to understand the relationship between dual class shares and long-term company performance?
• How important is context (jurisdictional heritage, culture, rule of law, stage of a company’s life cycle) in influencing the positive or negative impact of dual class structures? Can every country be a Sweden?
• Do issuers and underwriters have an advantage in bargaining power in influencing listing rules, especially in the cases where the stock exchange itself is a for profit entity? Are stock exchanges managing their conflicts of interest effectively?
• Are sunset clauses the best compromise for investors? Does it make sense for investors to call for a one size fits all sunset period? If not, what are the factors that should be considered in terms of a sunset period?
• Are index funds a captive market for retail index investors who might otherwise oppose dual class shares?
• What problem is relaxing dual class restrictions supposed to solve for exchanges?  Especially in the tech sector, can this be the difference expected to attract new promising young tech companies and remove the competitive advantage of the US or other overseas markets with a more established technology investor base?
• What has been the experience in Hong Kong and Singapore since they lifted their dual class restrictions?

So while we may have hit an inflection point in the dual class debate with the growing regulatory acceptance of differential ownership structure, the discussion is not over.

We very much encourage you to consider responding to this blog series on dual class shares, with crisply written and argued views— in 800 to 900 words!