By John Filar Atwood
In comments to the U.K. Treasury in connection with its review of the U.K. listings regime and dual-class structure rules, the Council of Institutional Investors (CII) voiced its opposition to any expansion of dual-class share offerings. CII, which supports the one share-one vote principle, said that expanding dual class strictures would be inconsistent with the London Stock Exchange’s goal of promoting high standards of corporate governance and shareholder rights.
CII believes that every share of a public company’s common stock should have equal voting rights, but has watched over the past 30 years as more companies have gone public with unequal voting rights, thereby eroding corporate governance standards. CII acknowledged that U.S. stock exchanges played a prominent role in that erosion, but asked the U.K. not to yield to this "race to the bottom" pressure.
In the letter, CII said that its primary concern with the expansion of dual-class shares is the principal-agent risk that increases for investors when equity structures skew the alignment of ownership and voting rights. When a company goes to the capital markets to raise money from the public, equity investors with the same residual claims should have equal protections and rights, including the right to vote in proportion to the size of their holdings, CII stated.
CII argued that its concerns over unequal voting rights are supported by research that shows that negative effects of unequal voting rights tend to develop in the medium to long-term. The group noted that in recent years some new companies with dynamic leadership and innovative ideas that have unequal voting rights have attracted capital on public markets with limited apparent valuation discount shortly after the IPO. Over time, however, the valuation of those companies tends to decline, CII noted.
Independent research. The group cited numerous studies that indicate that as the gap between ownership and control widens, the agency costs of insider control and lack of shareholder accountability increase. Moreover, a company’s founders’ entrepreneurial skills and insights that initially propelled a company become dated, and risks change in ways not foreseen by investors at the time of the IPO.
Among the research cited by CII was a study by the European Corporate Governance Institute that shows that even at innovative companies where multi-class structures correlate to a value premium at the time of the IPO, that premium dissipates within six to nine years before turning negative. Similarly, a study by former SEC Commissioner Robert Jackson Jr. found that by seven years after an IPO, perpetual multi-class firms exhibit valuations that are significantly lower than firms with "sunset" provisions.
Time-based sunsets. CII suggested time-based sunsets as a way to mitigate long-term investor risks from dual-class structures. The group recognized that shareholder voting rights can be seen by some founders as creating negative short-term pressure, and that there may be pressures in the U.K. to expand dual-class structures to attract fast-growing new economy companies. If the U.K. decides to go this way, CII recommended that it mandate a time-defined sunset on unequal voting rights of no more than seven years.
In this regard, CII noted that research indicates that any benefits of holding dual-class shares decline over time, with companies with dual-class shares eventually tending to be undervalued as compared to their peers. According to CII, one study found that controlling shareholders have perverse incentives to retain dual-class structures even when those structures become inefficient over time. This makes it difficult for dual-class companies to ever regain alignment of ownership and voting rights unless there are time-based sunsets in place, the group stated.
CII pointed out that its support of reasonable time-based sunsets is backed both by academic studies and by the fact that a growing number of companies that go public in the U.S. with differential voting rights are incorporating time-based sunsets into those structures. Accordingly, CII urged the U.K. to decide that any exchange listing rules that allow dual-class shares must also include mandatory time-based sunsets, regardless of premium or non-premium status.