This article has been written by Gaurav Garg pursuing Diploma in US Corporate Law and Paralegal Studies and has been edited by Oishika Banerji (Team Lawsikho). 

This article has been published by Sneha Mahawar.

Introduction

A company divides its capital into small equal units of a finite number. Each unit is known as a share. In simple terms, a share is a percentage of ownership in a company or a financial asset. In a balance sheet, it is shown under the head of capital of the company. Investors who hold shares in any company are known as shareholders. A dual class share is when a single firm issues two different levels of shares with varying voting rights and dividend distributions.  It entails one corporation providing at least two stock classes. A dual-class structure firm or stock has two or more classes of shares with differing voting rights. Insiders are typically given access to a class of shares with higher control and voting rights, whereas the general public is given access to a class of shares with limited or no voting rights. This article discusses the concept of dual-class shares in detail. 

Types of shares 

There are many types of shares, some of them are common shares (equity shares) and preference shares. 

Equity shareholders have voting right and receive dividends according to the revenue the company earns (excludes the part retained by the company as a reserve from the profit/revenue). Whereas preference equity shareholders don’t usually have voting rights but have a preference in the payment of dividends. In case of dissolution of the company.  

Preference shareholders will get a preference over equity shareholders. The value of a share a company issues depends on its face value, the company’s capital divided by the total number of shares. A firm’s authorised capital refers to the maximum amount of shares it has allowed to share and a firm paid-up share capital is the shares it issued to the public. 

Equity shares can be issued to the person who wants voting power and ownership. This type of share is traded actively in the secondary or stock market. These shareholders also get voting rights in company meetings. They also get the right to take part in managerial functions. They are also entitled to get dividends for investing their money in the company. However, the dividend on these shares is not fixed and may vary yearly depending on the company’s profit.

One more type of share is Differential Voting Right (DVR) shares. The DVR shareholders have fewer voting rights compared to equity shareholders. To diminish the voting privileges, companies provide an extra dividend to these shareholders. As DVR shares have fewer voting rights, their prices are also low. Due to the price gap between equity shares and DVR shares, the interest between them got balanced. 

Difference between share and stock 

Some people think that there is no difference between stock and share and they can be used interchangeably. There is a thin line difference between stock and share. 

Stock refers to the company that issues it. Stock represents an ownership interest in a company. A stockholder owns stock in a company which can mean different things, whereas, a share is a unit of measurement of your ownership/stock in a company. A share represents a specific unit of ownership of a stock. A shareholder owns shares of stock in a company. The stock is wider than the share. Share means share capital of one kind of stock but stock includes various kinds of stock in which a shareholder wants to invest.

For example, A owns stock @ 12% interest in Google on the other hand B purchased 12000 shares @ 12% interest in Google, but these 12000 shares don’t need to be from the same stock from which A has purchased the share, maybe such are from different stock in the same company.

Introduction of dual-class shares 

Dual stock shares are also known as multi-class shares. Dual stock shares refer to a type of share structure in which public companies, that are registered with the company act, issue two classes of common shares to the public with different voting rights. Typically, one class of share has superior voting rights over the other. The shares with superior voting rights are usually held by the founders, family members, management team, and other insiders, while another class of shares is sold to public investors just for financial support.

Companies often use a dual class of shares to maintain control by insiders while raising capital/ finance from outside investors. It has been a subject of controversy, as it can result in insider control and lead to poor corporate governance. 

For example- Company X has issued two classes of shares i.e., Class A and Class B. Class A shares are issued to public investors, and Class B shares were issued to its directors, employees, and founders for retaining control and voting rights. 

Controversies of dual-class shares 

• The controversy surrounding dual-class shares stems from the fact that they can give disproportionate voting power to insiders and company founders at the expense of public investors. This can lead to a lack of accountability and oversight, as insiders who hold a dominant voting position may make decisions that do not represent the interests of all shareholders.
• It leads to poor corporate governance. For good governance, the principles by OECD that a company should strictly adhere to are as follows:
  • The right of shareholders.
  • Equitable treatment of shareholders.
  • The role of stakeholders in corporate governance.
  • Disclosure and transparency. 

The above principles are neglected by companies that issue dual-class shares. Those companies neglect equal distribution of rights but still, the risk is the same. All shareholders are not treated equally as some have even no say in managerial functions. They are just like a financial institution that provides money. There is no disclosure of information or data which helps these shareholders to analyse the position of the company.

• The dual-class shares go against the principle of equal voting rights of all shareholders, violate corporate governance standards, and can lead to a lack of transparency and accountability. It was also argued that this structure can make it difficult for shareholders to influence management decisions and can make companies less attractive to potential investors.
• On the other hand, proponents of dual-class shares argue that they allow company founders and insiders with substantial experience and knowledge about the company to retain control and make long-term decisions that benefit the company’s growth and development. They argue that this structure can save companies from involving short-term investors in management decisions and attract long-term investors who are willing to invest in companies with a clear vision and strong leadership. This will help the company grow and run smoothly.
• Small group of shareholders controls the company’s whole management, and the majority have no say. A large group possessed a majority of capital but still, their voting power was less. Some claimed it is an unequal distribution of risk. On one side, Founders, Families, etc are getting the capital from the company at minimum economic risk on the other hand, shareholders still carry a major part of the risk.

Some of the real companies that issued dual-class shares are as follows:

• Alphabet subsidiary Google (GOOGL v. GOOG)

When Google first went public in 2004, the company created two classes of common stock i.e., Class A (GOOG) and Class B(GOOGLE). Google sold shares of its Class A stock to the public whereas its co-founders Larry Page and Sergey Brin, along with other Google executives, retained Class B shares. Each share of Google’s Class B stock held 10 times the voting rights of each share of Class A stock. i.e., with every share of Class A, a shareholder got one voting right whereas a Class B shareholder got 10 voting rights against one Class B share. This share structure allowed Alphabet insiders to maintain majority voting rights even if they did not maintain majority ownership of the company.

• Ford

The dual-class structure at Ford, for instance, gives the Ford family control of 40% of the voting power, while owning a small percentage of the company’s total equity. The founders and family members retained the class B shares and got a majority of managerial power.

Bill Ford Jr. Said:

“I think it’s really important that the family legacy continues. It gives us a face and maybe a humanity that a lot of other companies don’t have.”

“I’m in this for the long haul. This is my life and I love the company,” he said. “I really believe that we are headed for an incredible future.”

• EchoStar Communications

The CEO of EchoStar Communications, Charlie Ergen, owned around 5% of the company’s stock, but his voting rights per share gave him around 90% of the voting power. He retained a major part of managerial power through only a small part of shares which represents very bad corporate governance. 

• Facebook

Facebook has a dual-class structure i.e., Class A shares and Class B shares. Those shareholders who have Class A stock get one share of one vote; On the other hand, Zuckerberg, executive management, and directors are Class B voters in which one share equals 10 votes. Zuckerberg himself owns 75% of Facebook’s Class B shares which gives him control of 58% of Facebook’s vote. The founders want to retain the whole controlling power as they do want this company to get close.  

The Facebook CEO/Chairman debate has come into clear focus at the recent annual shareholders meeting where 68% of outside shareholders supported a proposal to make the role of Chairman an independent position after voicing concern and disapproval over how CEO and Chairman, Mark Zuckerberg, has handled various missteps including a security breach in September that impacted 30 million Facebook accounts. Additionally, 83% of outside investors voted to replace the current dual-class share structure with a “one share, one vote” system. This is one of the best examples of Bad Corporate Governance.

• Berkshire Hathaway- Warren Buffett

Investors interested in buying into Warren Buffett’s Berkshire Hathaway have two options: Class A stock (BRK-A) and Class B stock (BRK-B). Berkshire Hathaway Class A closed at $454,400 per share, compared with $301 per share for the Class B stock. one Class A share might be accompanied by five voting rights, while one Class B share could have only one right to vote. 

Analysis of trade on NYSE

• Traded on the New York Stock Exchange (NYSE), only 1.7% of the issued common stock gave minority stakeholders complete voting control over the majority shareholders. This unequal treatment forced the NYSE to issue a ban on Dual Class Shares in 1926. Later, in 1940, the NYSE barred listed companies from issuing non-voting stock and prohibited superior voting stock from constituting more than 18.5% of all outstanding common shares. According to various sources, these effectively limited most multi-class NYSE listings. 
• In the early 1980s, NYSE faced growing competition from the American Stock Exchange (AMEX), which allowed Dual Class Shares with some conditions, such as allowing classes of stocks with no more than a 10:1 voting ratio between them, and especially the NASDAQ, which had no Dual Class Share restrictions. 
• Subsequently, in 1994, the NYSE, NASDAQ, and AMEX adopted similar policies that permitted their listed firms initially to issue multi-class shares but did not allow them to subsequently reduce the stock’s voting rights during recapitalizations. But, due to enhanced competition and the need for growth in the market, big companies started to convert their shares into dual-class shares. Small companies do not afford to take risks and lose their shareholders. 

To encourage small companies, sunset provisions have been established which give a chance to companies to convert their shares from multi-class shares into single-class shares.   

Sunset provision 

Various companies with dual-class shares have “sunset” measures in their Article of Association which provides that “A company common shares will be being converted into a single voting share class in future” if the following anticipated events will happen which are as follows:

• The directors who manage the company or any other person who takes managerial decisions will be permanently disabled or die, or a founder of the company will be permanently disabled or die or,
• A person who manages the whole affairs of the company will get retired, and at the time of attainment of such retirement sunset provision will come into operation.  
• A fixed-time-based sunset, in which the conversion of multi-class stock to uniform voting shares occurs at a specified future date. Initially, Dual-class share is beneficial for a company after an IPO, over time dual-class share lose their value to the company because of their repercussions or disadvantages.  Time-based sunsets range from three to 20 years, with 10 and then seven years reportedly being the most common.

The underlying rationale is that firms benefit from the presence of healthy and experienced founders, and they need privacy to take innovative decisions without any interference for the growth of the company and their ownership of superior voting stock will bolster that. They always want to protect the company for which they had spent half of their life. To encourage these promoters or founders these provisions exist.

Analysis and reports

• Firstly, after a detailed analysis and study, it was found that the value of the firm declined after a certain period. Perhaps, at the time of IPO, they may enjoy the benefits of dual-class shares but in the long term, it has been seen that their value declined.
• Secondly, it is not necessary that dual-class shares are always bad for corporate governance. We need more research on this before coming up with a solution. It is true that in the long-term firm value got declined but that is not applied to every industry. Industries based on innovation and technology may issue their share in a single class share structure as these industries need privacy and control over the information or formula it innovates.
• Thirdly, balance needs to be maintained by the founders and directors. They should have given incentives to keep their shareholders happy. They should give extra profits to the shareholders and give them access to financial reports and related information which balance or maintain Corporate Governance in the company.
• Fourthly, regulators or policymakers should observe the evidence in their markets and jurisdictions. They should see whether control in hand should be necessary, whether disclosure of information to all shareholders will harm the company, etc.
• Lastly, if policymakers or regulators make a strict rule and impose a high-level burden of proof to sue corporate insiders (Founders, directors, etc.), it will be bad for the Corporate Governance of the company to allow the use of dual-class shares because in that case, it will become very hard to prevent the promoters and directors from manipulating the records whereas, if they do not impose a high burden of proof on the plaintiff, public investors will enjoy a greater level of protection because corporate insiders will be afraid of getting sued by the shareholders. Therefore, shareholders will get more incentives to avoid violating the law. Therefore, in countries with more friendly litigation rules, especially if these rules include the existence of class actions, there will be a lower risk associated with allowing the use of dual-class shares. It will be easy to expose a company. Therefore, regulators should be stricter about the possibility of allowing companies to go public with dual-class shares. If they are allowed, then rules and procedures should be convenient and liberal. There is a principal “doctrine of the corporate veil” which helps the company to expose the company and prevent the company from concealing or manipulating its records from shareholders with fewer voting rights. 

Conclusion 

In my opinion, companies should be allowed to issue dual-class shares provided balance should be maintained by following the principles of corporate governance. Additional incentives should be awarded to the classes of shareholders who have not been given voting rights. There is no unfair treatment with two classes of shareholders as during IPO it has been revealed by companies before issuing its share in public that it is issuing multiple class shares. Shareholders voluntarily purchased such shares after agreeing to all terms and conditions. Shareholders voluntarily carry a major part of the risk for higher profit. Investors should consider the effect of dual-class ownership on company growth, the procedural laws of such countries, and the incentives given for compromising their managerial rights. 

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