The Reality Behind Dual Class Shares

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The answer, according to a new study by ISS, is mixed.
Mark Zuckerberg, CFO of Facebook
He’s a fan.

Some of the most prominent companies of our era use them, from Facebook and Alphabet to Berkshire Hathaway. So did seven of the 10 biggest IPOs this year, including Lyft, Pinterest and Levi Strauss.

They’re dual-class shares, endowing those who hold them with super-voting abilities that effectively leave them in control of the company regardless of what outside investors do—and they’re more popular than ever. Overall, the number of companies going public using this type of share structure went from just 4% in 2009 to 14% in 2018. Some 7% of all Russell 3,000 companies now have this kind of structure, by ISS’s count, and almost 9% of non-S&P 1500 companies use them—nearly double the number using them in the S&P 500.

Proponents argue they protect management against exactly the kind of short-termism so many in the good-governance crowd rail against, allowing companies to make the kind of long-term bets needed to really grow a business—especially one with unproven technology. Opponents say they’re flat-out undemocratic, undermining common shareholders—and capitalism itself. (For the record, I’ve long been in this second camp—especially when it comes to Facebook.)

But do they work? Do they actually help companies perform better? It’s a great question—and the answer, according to a new study by proxy advisory firm Institutional Shareholder Services is, well, mixed.

ISS found (perhaps unsurprisingly given that it’s ISS) that dual-class companies were much less likely than their one-share, one-vote peers to track some of ISS’s favored corporate-governance benchmarks. They had more CFO-related transactions (raising fears of conflicts of interest), fewer independent board chairs and were less likely to disclose their director evaluation process. Interestingly, ISS found the dual-class firms had more gender diversity in the C-Suite versus one-share, one-vote firms, but less gender diversity in the boardroom.

But what about the most important, bottom-line question—do these kind of companies perform better financially? Using Economic Value Added methodology (EVA), which measures profitability after subtracting the full cost of capital, dual-class shares do outperform peers, on what’s known as EVA Margin, that is, EVA/Total Revenues.

But dual-class share firms underperform when it comes to EVA Momentum, the rate of improvement in profitability over time. “The advantage that dual-class firms may have established appears to be eroding over time,” writes Kosmas Papadopoulos, managing editor at ISS Analytics. “This trend highlights the risk of stasis upon achieving a certain level of performance.”

In other words, the company performance depends—as it does with any other kind of company—on the performance of those who control the company. With one big difference: If something goes wrong here, there’s nothing anyone can do about it.

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