18 Feb 2016
“The one share, one vote rule is good for listed companies, good for the shareholders, and good for the country.”
JOHN J. PEHLAN IN 1986, A CHAIRMAN OF NYSE BACK THEN
What Is a Dual-Class Share Structure?
A dual-class share structure (“DCSS”) means a structure in which a firm has more than one share class with different rights, usually voting rights, attached to them. In a typical DCSS, insiders hold shares with multiple votes per share when the public receives shares with only one vote per share. It is also possible that shares issued to the public do not have any voting power. A characteristic feature of DCSSs is that they allow shareholders to achieve a controlling position by investing disproportionally low share of capital.
Especially in the United States, 1980s were a golden period of public takeovers, and as DCSSs serve as efficient anti-takeover mechanisms, such structures were increasingly adopted to protect managements against hostile takeovers. However, DCSSs are bad for corporate governance, and driven by an increased academic and public interest in corporate governance throughout the 1990s, the market faced a trend where dual-class companies unified their share structures back into a single class.
In 2004, a new wave of dual-class IPOs began when Google adopted a DCSS for its IPO. After Google’s IPO companies like LinkedIn, Groupon, Yelp, Zynga and Alibaba have chosen to execute their IPOs with DCSS. It has been speculated that the most recent DCSSs have been adopted to protect companies from activist investors.
The financial bottom line is that DCSSs tend to increase principal-agent costs and private benefits of insiders, and consequently destroy shareholder value. Furthermore, DCSSs weaken, on average, the long-term performance of a company and institutional investors tend to avoid companies which have more than one share class. It has been shown that the firm value of an average European firm with dual-class shares is approximately 19 percent lower than a firm with only one share class.
In the light of the above mentioned, it is not surprising that both share classes of Stockmann plc rocketed on 29 January, when Stockmann announced that its shareholder HTT STC Holding Ltd, representing over 10 per cent of the shares in Stockmann, had proposed the Annual General Meeting (to be held on 15 March) to unify Stockmann’s current share classes into a single class. The positive market reaction occurred, despite the fact that in this stage it is uncertain whether the Annual General Meeting will pass the proposed resolution.
As the topic of DCSSs is current again and as they have always been common in Europe, including Finland, I chose to research the following questions in my Master’s thesis for finance:
(i) Why have some publicly listed companies in Finland chosen to create DCSSs?
(ii) What common characteristics do publicly listed companies in Finland with DCSSs have?
(iii) Why have publicly listed companies in Finland chosen to unify their share structures into a single class?
First, while analysing reasons why some Finnish companies have chosen to carry out their IPOs with DCSSs during the recent years, I found that none of these companies had given any justifications for such structures. In a way, DCSSs are taken as given and are only flagged as risks in prospectuses. Perhaps, in the future, as investors will become more sophisticated, they will require well-grounded justifications for DCSSs.
Second, when running a binary choice regression analysis of Finnish publicly listed companies, I found that there are statistically significant and positive correlations between a DCSSs and (i) the size of a company and (ii) existence of anti-takeover provisions (such as poison pills, voting ceilings and staggered boards) in the Articles of Association of a company. These findings are against financing theory, as larger companies and companies already having an anti-takeover mechanism in their Articles of Association should already be protected against hostile takeovers. On the other hand, large Finnish listed companies are relatively small on an international scale, and therefore the size does not protect them against global private equity or industrial players.
In addition, companies operating in the health care industry or providing consumer goods tend to have two share classes more often than other companies. In contrast, technology companies tend to have a DCSS more seldom than companies operating in other businesses. This can be considered as surprising in light of the current international practice, in which large technology companies have chosen to adopt DCSSs. Furthermore, there is some evidence that companies which have been longer subject to public trading have more often a DCSS (not a statistically significant finding) which is also against the financing theory, as DCSSs are usually seen as temporary structures which are deployed in situations where simultaneously outside equity is needed and management is willing to hold control over the company.
Finally, when analysing public statements of companies that have chosen to unify their DCSS into a single class structure, I found that such companies have emphasized that the unification will clarify the ownership structure, increase public interest towards the company’s share and improve the liquidity of shares. It was also stated that the unification is beneficial in order for a company to raise equity financing from investors.
It remains to be seen whether the new wave of dual-class IPOs will also strike to the Finnish market or will a rise of corporate governance, little by little, result in marginalisation of DCSS on Nasdaq OMX Helsinki. Personally, I would bet on the latter alternative. Especially I am anticipating increased pressure from institutional investors towards dual-class companies to unify their share classes.
The author’s Master’s thesis is electronically available at: http://epub.lib.aalto.fi/fi/ethesis/pdf/14207/hse_ethesis_14207.pdf