Hi everyone! I’ve really enjoyed our class discussions this term, and given our recent conversations regarding the Rogers saga and shareholder democracy, I thought I was pass along the paper I wrote for the version of this course I took back in 2022. Everything is surprisingly still relevant!
Introduction
Of the core characteristics that define a corporation, shareholder control (specifically that shareholders must be the ultimate repository of control in an incorporated company) is often considered to the cornerstone of the modern corporation. Alongside the concept of corporate personhood and the limited liability of shareholders, it can be argued that the power given to shareholders to govern corporate activities is the fundamental basis for a corporation’s existence – without it, such a company cannot exist (Nathan, 2010). At the root of this principle is the idea of a shareholder democracy: that the governance structures of corporations should be based off of the characteristics of the modern political democracies of North America and Europe (Gordon, 2021). In fact, many would consider most corporations to be achieving this goal quite well, allowing shareholders to have (at least a semi-) active role in the operation of a firm The reality is, however, that the vast majority of corporations have elements in their governance structures that are wholly undemocratic, and contrary to the basic features of a “democracy.” While there of many examples of these, there is no greater example of this fallacy than the existence of dual-class (and even triple-class) share structures for the common stock of corporations. This essay will explore the existence of such systems in greater depth, explore some of their benefits and shortcomings, and finally argue why dual-class share structures should be severely limited or prohibited in order to strengthen shareholder democracy in modern corporations.
Shareholder Equality: Fact or Fiction in a Dual-Class Share Structure?
“One person, one vote.” Since its origin in the 19th century, this quote is the perfect embodiment of one of the elementary tenets of a democracy: that all individuals should have equal representation in voting. In a corporate context, this can be best translated to “one share, one vote.” It would be expected that corporations purporting to be democratic institutions (and the laws that govern their existence) would emulate this principle to give equal power to common shares when distributing voting power. Yet, the existence of the dual-class share structure for common stock completely undermines the idea of equality of voting shares. In such systems, different classes of shares can be assigned different voting rights, essentially giving specific shareholders voting control unequal to the amount of equity they hold in the company (McClure, 2021). Designed to offer “insiders” greater control and voting rights in a corporation while still allowing the general public an investment opportunity, the reality is that these systems allow founders and their families, executives, and chosen others to control the majority voting power with a relatively small percentage of total equity (and thus more control of the decision-making power while taking on a lesser percentage of the risk) (Hayes, 2021).[1]
Overall, it is easy to see the unfairness of dual-class share structures, and one has to look no further than the recent Rogers saga to view a telling example of how even just one individual can be given almost “dictatorial” power over a publicly-traded corporation (Cohen et al., 2021).[2] The millions of institutional, corporate, and retail shareholders (myself included) that had to stand by and watch as one man almost unilaterally determined the governance makeup and direction of a publicly traded corporation certainly cannot feel that shareholder democracy is alive and well within Rogers. While the court agreed that Rogers’ Articles and the laws of British Columbia (namely the Business Corporations Act) authorized Mr. Rogers to take the actions that he did, the fact that a dual-class share structure allowed for the governance of a multi-billion dollar national corporation to become paralysed as, in the words of Justice Fitzpatrick, “two ‘duelling’ Boards both proclaiming that they [were] the ‘valid’ Board” while the remainder of the shareholders were forced to sit and watch is frankly ludicrous and the antithesis of proper democratic governance (Rogers v Rogers Communications Inc., 2021).
The Benefits of Unequal Voting Power
Despite the clear drawbacks, this is not to say that dual-class share structures do not provide any advantages for corporations (and investors). Proponents of such systems rightly point out that certain industries, such as media companies, can benefit from a dual-class structure to maintain news independence (Govindarajan, 2018). Another industry that has particularly benefited from such a structure are the technology companies of the United States, which have largely relied on the influence and expertise of their founders to achieve their success. It can be argued that without the option of a dual-class share structure, many of these companies would not have gone public as early as they did (if at all) due to their founders’ fears of losing control of their companies, otherwise depriving investors of the opportunity to gain financial benefit from the massive growth companies like Snapchat and Facebook have seen (Howard, 2021). There is even empirical evidence that corporations with dual-class structures may provide greater returns for shareholders (although academic research is divided) (Tahmincioglu, 2018).[3]
Those that support the existence of dual-class share structures may also argue that the right to form a corporation using this system is something owed to company founders, and that investors have a choice whether to invest in corporations that utilize such a structure. If prospective shareholders are unhappy or uncomfortable with purchasing shares in a corporation in which they are forced to give up their right to an equal vote in favour of the opportunity to be a shareholder, then they should simply choose not to invest in that company. While this is true (no one is forcing any investor to purchase shares in a particular corporation), it does beg the question: should we allow, as a matter of policy, the opportunity for corporations to actively undermine the concept of shareholder democracy from the moment they are created? Why should investors who (in the opinion of many) rightly protest dual-class share structures be punished and have investment opportunities withheld from them simply for taking a stand against the active subversion of one of the key principles of any corporation: democracy?
The Future of the Dual-Class Share Structure
Overall, regardless of the benefits that dual-class share structures can provide for both a corporation and investors, their negative effects and contribution to the dilution of the shareholder democracy makes it clear that these systems should be severely restricted, if not prohibited. While some corporations such as Shell and Alimentation Couche-Tard have recently done away with their dual-class share structures, some of the biggest and most influential corporations in the world still maintain this inequitable system (George-Cosh, 2021; Briançon, 2021). Examples include Alphabet, Meta, and Berkshire-Hathaway, whose Class B shares in particular offer 1/1,500th the interest of its A-class shares, but 1/10,000th of the voting power (McClure, 2021). The bottom line is that the benefits of dual-class structures simply do not outweigh the costs, and as long as they are allowed to continue unrestricted, shareholder democracy will continue to be hindered.
As such, it is incumbent on regulators to take action. Whether this is done at a legislative level or through the rules of the various stock exchanges, it is imperative the option for a dual-class share structure for corporations be phased out in favour of a more democratic system.[4] While an immediate and complete elimination of this system may be preferable in the name of complete equity and fairness, the lack of feasibility of such a controversial change signifies a middle-ground may need to be pursued. This could come in the form of mandatory sunset clauses for dual-class share offerings. Under sunset clauses, corporations would be mandated, in their certificates of incorporation, to include a provision that dictates all “Class A” shares be converted into regular “Class B” voting shares after a certain period (or vice versa), thus equalizing the voting rights of all shareholders.[5] By adopting such a system, a balance can be struck between allowing corporations and their founders a means of mitigating the risk they face of losing control over the direction of their companies to institutional investors and hostile takeovers in the short-term, while protecting investors’ rights and the shareholder democracy in the long-term. While such a compromise is certainly not perfectly ideal, it establishes a practical method of allowing companies the flexibility of independence to make business decisions to grow a firm (ultimately also benefiting minority shareholders) while at the same time providing a consistent way to ensure the shareholder democracy is protected in the long run (Kim & Michaely, 2019).
Conclusion
When comparing the dual-class share structure for corporations with the idea of shareholder democracy, it is clear that these two concepts are not fully compatible. Given the importance of the principle of shareholder control within a corporation, dual-class share structures certainly fall short in upholding equal representation, the underlying basic notion within any democratic system. As a result, these inequitable systems of corporate ownership should be drastically limited through the mandatory implementation of sunset clauses, if not prohibited outright. Despite the benefits they may bring, their negative effects on the rights of minority shareholders and their contribution to the overall dilution of shareholder democracy means dual-class structures can no longer be justified and should be phased out. While the prevalent use of such systems in some of today’s most influential technology companies means regulatory changes are unlikely to happen quickly, it has come time for regulators to take the notion of equal representation within corporations seriously and enact this change (among others) to modernize corporate governance structures and foster equitable opportunities for all investors.
Footnotes
[1] For example, if the Festinger family wished to take their privately held company Festinger Milkshake Co. public to raise capital, while still maintaining overall control of the company, they could structure their IPO so that two classes of shares are created. Class A shares would be held almost entirely by the Festinger family, and each share would carry 10 votes compared to the 1 vote (or even 0 votes) each publicly traded Class B share offered to the general public. In theory, this could allow the Festinger family to control a majority of the voting power with a minority of the overall equity in the company – a hardly democratic arrangement.
[2] In this case, Edward Rogers (by virtue of his control of the Rogers family trust that owns 97% of the Class A voting shares) was able to almost singlehandedly gain control of the company when he was ousted as Chairman by the Rogers Board of Directors during a CEO dispute. Instead of acquiescing to the Board’s decision, Mr. Rogers instead used his control of the voting shares to simply replace 5 members of the Board and reinstate himself as the Chair without a meeting of the shareholders, even over his own family’s objections (Stephenson, 2021).
[3] An analysis by MSCI showed that the unequal voting stocks outperformed the market over the period from 2007-2017, and “aggressive-growth and family-controlled dual-class companies” tend to display higher long-term shareholder returns. On the other hand, some other studies have found lower stock returns for dual-class corporations compared to single-class firms in the same industry, with lower trading prices compared to fundamentals and higher executive compensation, value destroying acquisitions, and management entrenchment (Govindarajan, 2018).
[4] For example, an equal voting share common stock voting structure, in which all shares are afforded the same amount of voting rights. This is not to say that certain individuals or groups cannot be allowed exercise control over a certain corporation, but rather it forces them to do so by truly taking ownership of the majority of a corporation’s shares and sharing the same amount of risk as every other shareholder would, should they be in the same position.
[5] This period can be a defined set of time (for example 5 years after an IPO), or rather after a predetermined set of conditions are met (such as the departure/retirement of founders). Additionally, provisions can be included that allow minority shareholders the right to extend the existence of a dual-class share structure through a vote after fixed period of time, a perfect example of truly affording democratic rights to minority investors to influence decisions that impact them (Sharfman, 2019).
Works Cited
Briançon, P. (2021, November 15). “Shell Stock Is Rising. The Company Is Moving Its HQ and Changing Its Name.” Barron’s. https://www.barrons.com/articles/royal-dutch-shell-stock-price-hq-51636973680
Cohen, R.B., Selby, C., & Hamaliuk, J. (2021, November 10). “Critics Call for Regulation of Dual-Class Shares in the Wake of the Recent Rogers Family Saga.” Cassels Brock & Blackwell LLP. https://cassels.com/insights/critics-call-for-regulation-of-dual-class-shares-in-the-wake-of-the-recent-rogers-family-saga/
George-Cosh, D. (2021, December 06). “Couche-Tard to convert dual-class shares to single stock on Dec. 8.” BNN Bloomberg. https://www.bnnbloomberg.ca/couche-tard-to-convert-dual-class-shares-to-single-stock-on-dec-8-1.1691832
Gordon, J. (2021, June 25). “Shareholder Democracy – Explained.” The Business Professor. https://thebusinessprofessor.com/en_US/business-governance/shareholder-democracy-definition
Govindarajan, V., Shivaram, R., Srivastava, A., & Enache, L. (2018, December 03). “Should Dual-Class Shares Be Banned?” Harvard Business Review. https://hbr.org/2018/12/should-dual-class-shares-be-banned
Hayes, A. (2021, November 24). “Dual Class Stock.” Investopedia. https://www.investopedia.com/terms/d/dualclassstock.asp
Howard, M. (2021, May 07). “Dual class share structures: how do they work and what are the pros and cons?” Charles Russel Speechlys. https://www.charlesrussellspeechlys.com/en/news-and-insights/insights/corporate/2021/ dual-class-share-structures-how-do-they-work-and-what-are-the-pros-and-cons/
Kim, H. & Michaely, R. (2019, May 03). “Sunset Provisions for Dual-Class Share Structures?” CFA Institute. https://blogs.cfainstitute.org/investor/2019/05/03/sunset-provisions-for-dual-class-share-structures/
McClure, B. (2021, March 11). “The Two Sides Of Dual-Class Shares.” Investopedia. https://www.investopedia.com/articles/fundamental/04/092204.asp
Nathan, C. (2010, June). “The Fallacy of Shareholder Democracy.” Latham & Watkins LLP. https://www.lw.com/thoughtLeadership/fallacy-of-shareholder-democracy
Rogers v Rogers Communications Inc., 2021 BCSC 2184 (CanLII), https://canlii.ca/t/jk727, retrieved on 2022, March 31.
Sharfman, B.S. (2019, April 24). “The Undesirability of Mandatory Time-Based Sunsets in Dual Class Share Structures: A Reply to Bebchuk and Kastiel.” Harvard Law School Forum on Corporate Governance. https://corpgov.law.harvard.edu/2019/04/24/the-undesirability-of-mandatory-time-based-sunsets-in-dual-class-share-structures-a-reply-to-bebchuk-and-kastiel/
Stephenson, A. (2021, October 26). “Rogers drama shows how owning a company is not the same thing as controlling it.” CBC News. https://www.cbc.ca/news/business/rogers-dual-class-shares-1.6225405
Tahmincioglu, E. (2018, August 30). “The Pros & Cons of the Dual-Class Stock Structure: Two corporate governance experts battle it out.” Directors & Boards. https://www.directorsandboards.com/news/pros-cons-dual-class-stock-structure-two-corporate-governance-experts-battle-it-out
Great paper.