Companies with weighted or limited voting rights through dual class share structures are disrupting investors’ stewardship efforts.
When companies aren’t performing to shareholder expectations, being able to vote at annual general meetings (AGMs) is a powerful tool in the investor arsenal. But what if voting doesn’t make a difference?
Facebook (now officially known as Meta Platforms) has recently been under pressure from its shareholders to address issues around governance and structure. Investors, such as the New York State Common Retirement Fund, have collectively filed eight shareholder proposals for consideration at Facebook’s next AGM. These include a request for more oversight of the reduction of harmful content and a review of the audit and risk committee.
There is little chance of success, however, because the firm’s dual class share structure (DCSS) gives Founder Mark Zuckerberg control of 58% of the votes, through ‘super-voting shares’.
DCSSs allow companies to issue more than one type of share, with those owned by the founder and company executives typically carrying more voting weight than shares made available to public investors. One Class A share could be worth ten votes compared to a one-vote Class B share. If a company’s management team owns a big percentage of Class A shares, they have the power to override any shareholder proposals they don’t agree with.
So, if Zuckerberg doesn’t want to change Meta’s governance structure, he can pretty easily say ‘no’.
This means that “voting power isn’t proportionate to economic risk”, says Matt Orsagh, Senior Director of Capital Markets Policy at the CFA Institute, a global association for investment professionals. For instance, while Zuckerberg has 58% of the voting power, he only owns 14% of the company.
Facebook isn’t the only big tech firm with a DCSS to fielding increasing pressure from shareholders. Google, or Alphabet, has 11 ESG-related proposals to contend with at its next AGM later this year, which call for increased disclosures, risk assessments and policy changes. The company’s Class B shares are owned by Google insiders and early investors, worth ten votes per share.
Historically, dual class shares have been most common in the US, and their popularity is “set to continue”, according to Glenn Davis, Director of Research at the Council of Institutional Investors (CII), an association promoting the interests of US-based asset owners. In the first half of 2021, 24% of US companies that went public did so with a DCSS, CII research showed, compared to 17% the year before.
But, with countries elsewhere softening dual class listing rules to encourage fast-growing, innovative companies to go public and invigorate equity markets, institutional investors are increasingly concerned that this approach is going to become a more widespread problem. One such example is the Netherlands, with the Euronext exchange in Amsterdam looking to list DCSS British investment trust Pershing Square Holdings.
That isn’t to say investors don’t have options. Collaborating to align their votes with other shareholders, engaging with policymakers and encouraging the use of sunset clauses are all ways they can still make their voices heard.
But DCSSs pose a particular challenge for asset owners looking to manage sustainability risks and impacts.
It’s well-documented that responsible investors typically prefer to employ engagement over divestment to hold companies accountable on ESG-related issues, such as setting net zero greenhouse gas (GHG) emissions targets.
The positive impact of a one share, one vote (OSOV) structure was famously demonstrated last year at oil and gas giant ExxonMobil’s AGM. Led by climate activist shareholder Engine No.1, investors voted for the election of two climate-conscious members to the company’s board of directors to help accelerate its transition to sustainable products and operations. The following month, a third climate-conscious, Engine No.1-nominated director was elected.
“Without OSOV the ExxonMobil result never would have happened,” says CII’s Davis.
With the rise in DCSS, investors’ ESG-related engagement strategies are suffering. “Our members are worried about the lack of accountability these companies have without being subject to powerful votes from asset owners,” Davis tells ESG Investor.
Worryingly, some companies are beginning to offer shares with no voting rights at all. One of the most famous examples occurred in 2017, when phone app Snapchat went public with no-vote shares, prompting outrage from investors. In 2021, other US-based companies, such as Rent the Runway and Sweetgreen, went public with shares denying voting powers to most investors.
Without the option to escalate engagement through voting, “the game has changed” and investors have to explore other means of holding companies accountable, says Orsagh.
If collaborating with other shareholders to bolster the power of their collective vote isn’t working, then investor engagements with regulators, policymakers and even index providers are paramount, says Athanasia Karananou, Director of Governance and Research at the Principles for Responsible Investment (PRI). “PRI signatories have engaged with index providers to make sure that companies with no voting rights are not listed in their indexes, for example,” she notes.
Absence of a OSOV structure doesn’t necessarily mean management doesn’t care about long-term sustainable success or the views of shareholders, observes Jeremy Richardson, Senior Portfolio Manager of Global Equities at RBC Global Asset Management (GAM). “Responsible management teams care about ensuring good stewardship and so will talk to all of their investors,” he says, noting that RBC GAM nonetheless has a preference for the OSOV structure.
In cases where OSOV companies are attempting to introduce a DCSS, investors speaking to ESG Investor are generally not supportive.
“When we vote at company shareholder meetings, we don’t support the issuance of shares with impaired or enhanced voting rights, and are likely to withhold support for capital-raising by companies with a structure that involves unequal voting rights,” says Kalina Lazarova, Head of Governance at BMO Global Asset Management.
Asset owners such as UK pension scheme Railpen are also publicly announcing their support of a OSOV structure. In its 2022 voting policy, the asset owner said that it will “vote against requests for the creation or continuation of DCSS”.
“Differential voting rights dilute the ability of minority shareholders, like Railpen, to effectively hold companies to account. We believe that long-term corporate success requires the shareholder voting rights to be directly linked to the shareholder’s economic stake,” the voting policy noted.
Introducing sunset clauses
When a company first goes public, the founder may want to maintain control in the early years, transitioning to the investor-preferred OSOV structure over time.
“In many cases, the success of these young companies going public hinges on the ingenuity of their founders. It isn’t always in investors’ best interests for a company to immediately lose that competitive edge because of market pressure for a traditional voting structure,” says PRI’s Karananou.
It’s an understandable preference at launch, Davis agrees. However, there are “many examples of companies that have been incredibly successful with a OSOV structure in place”, he adds, pointing out that Microsoft, Amazon and Apple have built tech empires while being held accountable by their investors.
A further issue is that a DCSS isn’t as financially sustainable over time, Davis says. He cites 2017 academic research that highlighted a short-term value premium following the debut of dual class firms, which “fades to a discount” within six to nine years.
Investors are increasingly engaging with companies before they go public, encouraging them to include sunset clauses if they decide to launch with a DCSS.
In legal terms, a sunset clause puts an expiry date on a statute, regulation or law unless further legislative action is taken to extend it. For companies with dual class shares, it represents a promise to transition to a traditional OSOV business model. The clause can be tied to an agreed period of time or to a specific circumstance, such as the company founder retiring.
Sunset clauses allow companies to maintain the initial innovative momentum, while simultaneously acknowledging their “destination of travel is equal voting rights for shareholders”, says RBC GAM’s Richardson. “They recognise that different companies are at different stages of maturity and should be treated accordingly,” he adds.
“The clause should be written into the governing documents of the company so that there’s no uncertainty for investors regarding when the transition will happen and how it will happen,” Davis says.
According to the CII, during the first half of 2021, 51% of newly public US dual class companies incorporated time-based sunsets. These are not all within the optimal timeframe, however; companies with too-long sunset clauses in place include Slack Technologies (10 years), Zoom Video Communications (15 years) and Airbnb (20 years).
DCSS companies that go public without a sunset clause present further challenges for investors – mostly in trying to get them to agree to the provision when they are already established in the market.
“When it’s not written into the governing documents from the outset of a company going public, it becomes much more complex and expensive for both investors and the company to untangle,” says Davis.
However, these companies may be subject to eventual divestment from investors if they don’t implement a strategy to transition, he warns.
Calm before the storm
Issues surrounding investor engagement with dual class companies are set to become more prevalent as regulations around the world soften.
Last year, the UK’s Financial Conduct Authority (FCA) finalised changes to UK listing rules to make it easier for companies listed on the premium segment of the London Stock Exchange to adopt DCSS, to attract more highly-valued and fast-growing companies to the UK. The new ruling is underpinned by a mandatory five-year sunset period that can only be extended if shareholders consent or the company de-lists altogether.
“We believe a mandatory, time-based sunset provision will be an effective safeguard against the entrenchment of weighted voting rights and the permanent exposure to moral hazard by minority shareholders,” the FCA said.
Not all investors welcome this change.
“This is concerning,” says BMO GAM’s Lazarova. “We believe that the introduction of DCSS would disincentivise investors, in particular institutional investors, from investing in IPOs.”
The PRI’s own response to the FCA’s consultation was cautious, emphasising the need to ensure investor safeguards are in place. “Strong governance standards shouldn’t be sacrificed for a perceived gain in increased UK IPOs,” says Karananou.
The UK is following in the footsteps of other parts of the world. In 2018, Hong Kong amended its rules to allow companies from emerging and innovative sectors to list with dual class shares or weighted voting rights. As a result, big tech companies such as China-based Alibaba were attracted to the market. Hong Kong is now considering whether or not to allow non-tech dual class companies to be listed.
Not every public launch of a company with a DCSS is successful. In March 2021, UK-based online delivery service Deliveroo launched its London IPO, including dual share classes. Deliveroo’s Founder, Will Shu, was able to control over 57% of the company’s voting rights, despite holding less than 7% of the company shares. Ultimately, share value fell by 30% as soon as the company went public, the equivalent of £2.3 billion.
While the UK and Hong Kong are opening up to dual class companies, the US is under pressure to tighten regulation.
In October 2021, CII submitted draft federal legislation that would prohibit US listings of dual class companies that don’t have a sunset provision of seven years or less from the time they go public. The draft noted that an unequal voting structure should only be allowed if all shareholders approve.
“Unfortunately, securities markets around the globe are liberalising their requirements on voting structures to compete with the US,” says Davis. “What was once primarily a US problem is now a global one that will likely be with us for some time.”