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Have you ever heard of dual-class share structures? Companies issuing different classes of shares during IPOs is a rising trend. Some shares come with unequal voting rights, giving founders and executives more power than regular investors. This raises questions about accountability, but some say it gives visionary founders the freedom to make long-term decisions.
In this article, we will take a closer look at how dual-class shares work and explore some possible solutions to balance the interests of everyone involved.
What are dual-class shares, and how do they work?
Companies sometimes issue different types of stocks, where one type has more voting power than the other. This is called a dual-class share structure. Typically, one type of stock might give the owner more say in company decisions than the other type. For example:
- Class A shares: Issued to founders and executives with 10 votes per share
- Class B shares: Issued to ordinary investors with 1 vote per share
Entrepreneurs can now raise funds from the public and still retain control over their companies through their super-voting shares. This means that despite owning only a small amount of the company’s total shares, founders can still have the majority of voting rights.
Many successful companies such as Facebook, Google, and Snap Inc. use this type of share classification. The economic benefits like dividends and sale proceeds are usually equal for both classes of shares.
History of Dual Class Structures
For almost 100 years, some companies have been using a special type of stock ownership called “dual-class shares.” This means that the people who started the company get to keep control over important decisions, even if they sell some of their shares to other people.
This idea has become more popular in recent years, especially for companies in the technology industry. This is because the people who started these companies have a very specific vision for how they want things to go, and they want to be independent of other people who might only care about making money quickly.
Although some people think this type of stock ownership is unfair, many stock exchanges around the world now allow it. In fact, almost 1 in 5 companies listed on major US stock exchanges use this type of ownership.
Arguments in favor of dual-class shares
Opponents offer several arguments supporting dual-class share initiatives:
- Shield founders from short-term pressures: Insulates visionary founders from shareholder demands for quick profits and allows them to focus on long-term goals.
- Prevent hostile takeovers: Consolidates control with founders and prevents hostile takeovers that may force change in strategy or leadership against the company’s interests.
- Flexibility for startups to raise capital: Technology startups with potential for disruption can raise adequate capital through IPOs without founders ceding control to investors focused on immediate financial returns.
Arguments against dual-class shares
However, critics believe dual-class shares have several drawbacks:
- Entrenches founders even if incompetent: Inefficient founders can remain entrenched even if they become unfit to lead the company through the latest technological and market changes.
- Encourages rash decisions: Shields founder decisions from shareholder scrutiny and facilitates unwise actions that may compromise the interests of ordinary investors as well as the long-term welfare of the company.
- Weakens shareholder democracy: Deprives ordinary shareholders of their basic right to influence management policies and key decisions through voting powers despite sharing financial risks and providing capital.
Dual class shares in India
In India, companies are allowed to issue shares with different voting rights, which means that some shareholders have more control over company decisions than others. This is called Differential Voting Right Shares (DVRs).
Unlike in the US, where companies can issue shares with different classes, this practice is not common in India. However, DVRs are a variant of this practice that was introduced in India in 2013, and they come with certain conditions that must be met.
• Only profitable firms can issue DVRs
• Total DVR equity cannot exceed 74% of total paid-up share capital
• Lower voting rights but higher dividends for ordinary shareholders
Some Indian companies, such as Tata Motors and Jain Irrigation, have tried to issue shares with differential voting rights (DVR). However, due to low awareness among investors, these shares have yet to gain much popularity.
Additionally, regulators are still figuring out how to address certain issues related to the rights of DVR shareholders.
Balancing interests of founders and ordinary shareholders
As more and more companies issue shares in different classes, it’s becoming more important to find a fair balance between the interests of the people who started the company and those who own regular shares. Some solutions could be:
- Sunset Provisions: Mandate sunset provisions that terminate superior shareholder rights after a fixed period unless extended through approval of ordinary shareholders.
- Increased Dividends: Offer higher dividends for ordinary shareholders to offset their lower voting rights.
- Capping Voting Disparities: Regulate maximum voting power disparity between classes of shares.
Conclusion
The debate around dual-class shares involves complex trade-offs between innovation, control, governance and shareholder democracy. Constructive solutions to address concerns around accountability while empowering founders are needed to shape optimal policies. With emerging variants like DVRs, India’s regulatory approach requires similar subtle considerations.
FAQs
Dual-class shares are a type of stock that some companies issue. These stocks have different voting rights for shareholders. Insiders like founders and executives are given more voting rights, while the public shareholders have fewer rights. This is done to allow insiders to make important decisions for the company while still raising money from the public.
Companies sometimes issue dual-class shares to allow their founders and top executives to focus on their long-term plans without getting distracted by the short-term demands of other shareholders. It can also help prevent the company from being taken over by other companies against its interests. Dual-class shares give the insiders more voting power, which means they have more control over important decisions and can resist hostile takeovers by other companies.
Some worry that a type of company ownership lets insiders make decisions that benefit themselves, not other owners. It also creates problems when key leaders leave. Critics want more regulation to protect owners.
Dual-class shares are becoming more common in the US and Asia-Pacific markets. Almost 20% of US firms have them. It’s a way for some shareholders to have more power than others, but there are concerns about whether it’s fair.
Rather than banning practices outright, some suggest measures like limited tenure, more insider ownership, independent board committees, classified boards, and transparency rules to balance innovation with fairness to shareholders.