All shares are equal, but some are more equal than others

Investors fighting for input and accountability at the companies they invest in is as old as the public corporation model. However, the prevalence of unequal share class structures, also called ‘dual class’ shares (i.e. two or more types of shares with different voting rights) continues to be an impediment. We believe equal voting is an essential right for shareholders and are strong proponents of the ‘one share, one vote’ standard, based on the principle that control of a company should be commensurate with the interests of investors generally.

Origins of the dual class share structure

The history of unequal voting rights goes way back. Accusations that directors at the Dutch East India Company in the 1600s bought company good for themselves at low prices¹ or the Dodge Brothers’ issuance of non-voting shares in 1926, leading to the New York Stock Exchange (NYSE) banning the structure until the 1980s,² are two such examples. The IPO (initial public offering) boom of technology companies this past decade brought this issue to the forefront once again.

While technology companies aren’t alone, as the chart shows, they far outpaced the market on dual-class adoption. Of the companies that instigated an IPO in 2021, ~46% of the technology companies did so with dual-class shares, compared with just ~23% of the non-technology companies.³ Market indices have taken note, with some excluding companies with such structures.

The pros and cons of dual-class shares

Proponents of dual-class shares often cite their desire to focus on the long term, which may be difficult to pursue amid market short-termism, as reason to keep dual-class shares.

However, there is compelling empirical research to indicate that the market is not as short-term as it is perceived to be. In a Harvard Law School Forum on Corporate Governance blog post, Charles Nathan and Kal Goldberg cite research that found that “there is no convincing economic evidence supporting the short-termism thesis”.⁴

The fear of activists derailing the company’s strategy is another point of concern often cited. However, there is evidence to show that activist impact is mixed. A study conducted by the Committee on Capital Markets Regulation found that “the majority of empirical literature regarding the short-term impact of activism on public companies is positive and the evidence regarding long-run effects… is ambiguous”.⁵

Finally, historically good performance can also be used to justify the status quo share structure.  However, we see risks in that view, particularly as long-term shareholders. The Securities and Exchange Commission found that, “Seven or more years out from their IPOs, firms with perpetual dual-class stock trade at a significant discount to those with sunset provisions [i.e. where the dual-class structure will expire at a set time in the future].”⁶

Even studies that found a positive correlation between controlled companies and patent output, quality, creativity and the efficient use of R&D in innovation tended to lose those benefits within 10 years following the IPO.⁷

Studies aside, some of the largest companies in the world continue to innovate and grow despite the perceived ‘burden’ of shareholder democracy – *Apple, *Netflix, *Amazon and *Tesla to name a few.

One share, one vote

Effective corporate governance is crucial to a functioning market, particularly as index investing strategies often necessitate investors to hold a company indefinitely. Shareholder democracy helps to enforce accountability and is the primary method through which shareholders may influence the company in which they are invested. By giving unequal voting rights, we believe dual-class structures create a roadblock to shareholder democracy, inhibiting the ability of shareholders to hold company directors to account.  

In our view there is enough growing evidence that dual-class structures are not benefiting long-term investors. As such, beginning in 2023, for those companies incorporated in the United States, we will vote against the re-election of the chair of the board when the company has not provided a plan to set a time limit on a dual-class structure (where it exists), or given shareholders the opportunity to vote on it.

We believe this should improve much needed accountability and sustain healthier markets.

*For illustrative purposes only. Reference to a particular security is on a historic basis and does not mean that the security is currently held or will be held within an LGIM portfolio. The above information does not constitute a recommendation to buy or sell any security. Assumptions, opinions and estimates are provided for illustrative purposes only. There is no guarantee that any forecasts made will come to pass.

1. http://www.shareholderforum.com/access/library/20100110_jongh.pdf

2. https://www.investopedia.com/terms/d/dualclassstock.asp

3. https://site.warrington.ufl.edu/ritter/files/IPOs-Dual-Class.pdf4.  https://corpgov.law.harvard.edu/2019/03/18/the-short-termism-thesis-dogma-vs-reality/#2

5. https://www.capmktsreg.org/wp-content/uploads/2020/04/Short-termism-04.08.2020-1.pdf

6. https://www.sec.gov/news/speech/perpetual-dual-class-stock-case-against-corporate-royalty

7. https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3183517