• Keith Dalrymple

Dual class shares and benevolent dictators

The Financial Times published a balance presentation of dual-class share debate in the context of the Lyft IPO. The article notes that “proponents of dual-class share structures say they allow founders to focus on longer-term goals and insulate them from attacks by activist investors”. The implication is that investors in general are short-term, particularly those of the activist bent.

The author attempts to support the supposition by noting that Facebook’s stock has done well since its IPO although Mr. Zuckerberg controls the company via super-voting shares with a minority economic stake. That’s a flimsy argument. We don’t know how the stock would have performed with a traditional voting structure. Better governance could have led to better stock performance, and stronger oversight would have resulted in fewer privacy scandals.

We have seen no evidence to support the thesis that ceding corporate control to founders or a small group of managers, thus insulating them from investors, produces better corporate decisions. Investors can benefit from the determination and vision of business leaders without ‘bending the knee’, so to speak.

Unfortunately, despite mounting evidence that good governance enhances returns, arguments against dual-class shares have not been particularly compelling. Pension & Investments recently published an article on the rising opposition to the practice. An individual from the CFA institute is quoted as saying that “good governance starts with one share, one vote”. Without investor pressures, performance lags and companies are awarded lower valuations. This may be true, but why?

The goal and problem of dual class shares are the same: they separate control from economic interest. When that occurs, management can use corporate resources to pursue their own interests, often to the detriment and expense of the non-controlling shareholders. Controlling shareholders may benefit directly or indirectly, financially or otherwise. For example, control can facilitate self-dealing or tunneling to intentionally divert profits away from the corporation to other entities. More mundanely, unchecked power can simply lead to poor decisions that, however unintentionally, erode shareholder returns.

Good governance and equal voting do not guarantee positive outcomes. However, the separation of control from economic interests that dual class structures engenders makes negative outcomes far more likely. Benevolent dictators are anomalies, not the rule.

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