A multi-class share structure is when a company has multiple classes of shares, usually with different voting or economic rights. These structures are commonly implemented in companies where the major shareholders, executives, or founders seek to maintain control over the business while still raising equity financing.
A typical case would be the creation of two classes of stock, where one class is entitled to 10 votes per share and the other only receives 1 vote per share. The first class (also known as supervoting shares) is held by insiders who seek to retain control, while the second class is sold to public investors to raise capital. Although multi-class shares have been used across many industries throughout history, they have become increasingly prevalent among technology companies in recent years. Some of the most famous companies with these mechanisms in place today are Ford, Alphabet, Nike, and Meta.
Astute investors should evaluate the impact of these structures when analyzing a company’s fundamentals. By understanding how these systems affect a company’s leadership and financing capabilities, investors can make more accurate predictions about future performance.
The primary effect of a multi-class share structure is that it allows the company's founders or executives to maintain control over the business. For all intents and purposes, their control over the corporation cannot be challenged by other shareholders or stakeholders unless they expressly allow it. This can have a material impact on corporate governance, since control will not meaningfully change as the makeup of the company’s particular shareholders evolves over time.
There are two main benefits of multi-class share structures:
Benefit 1: Inspire Confidence
The stability that comes with multi-class structures may contribute to the company’s credibility or respect with outside parties. When one person or group of people remains in power for a long period of time, they have the opportunity to develop long-term relationships with employees and business partners. These parties may then build great confidence about who’s in charge or who they’re dealing with. They can then unite under the single banner of an established business leader who they have faith in.
Someone who has already delivered great results and built a positive reputation for themselves may create trust and respect that fuels stronger collaboration. If key decision makers are constantly changing, then these relationships may not have enough time to develop and company culture may eventually suffer.
Controlling parties may also have the ability to develop a distinct brand that blends the corporate identity with their own. In some cases, they can even create a company history that is fundamentally intertwined with the family’s own legacy. If the family’s reputation is positive, then it may serve as another way of attracting people to work at the company.
Although securing control can contribute to this phenomena, many founders have built distinguished legacies simply as a matter of their success. Look no further than Walt Disney, Sam Walton, and Steve Jobs. For the rest of history, these companies will be closely associated with the personal traits of their founders.
In some cases, allocating control to a single person or group of people can increase external confidence in the company’s future prospects. This may be useful for drawing interested investors to finance new ventures. However, the controlling party must have a unique vision coupled with a strong track record to achieve such magnetism. In the absence of these qualities, the controlling party may fail to inspire confidence in new investors who have other investment opportunities at their disposal.
Benefit 2: Drive Long-Term Success
Multi-class share structures can also support innovation by allowing leaders to focus on the development of new products and services without having to worry about short-term considerations. This can help companies to stay ahead of the competition and drive long-term growth. Leaders can leverage their control to pursue an extraordinary vision, one that may bring significant costs today in exchange for much greater profitability in the future.
Another way that leaders can pursue long-term success is by ensuring that stakeholder interests are properly considered. Left to their own devices, shareholders may be self-serving at the expense of employees, customers, local communities, etc.
Many successful business leaders have looked after the interests of customers, employees, and communities to ensure the ultimate viability of their own companies:
“There is only one boss. The customer. And he can fire everybody in the company from the chairman on down, simply by spending his money somewhere else.”
“We built the Starbucks brand first with our people, not with consumers. Because we believed the best way to meet and exceed the expectations of our customers was to hire and train great people, we invested in employees.”
“The myth that profit maximization is the sole purpose of business has done enormous damage to the reputation of capitalism and the legitimacy of business in society. We need to recapture the narrative and restore it to its true essence: that the purpose of business is to improve our lives and to create value for stakeholders.”
Those are some of the main benefits that a company may see from instituting multi-class share structures, but here are the main drawbacks:
Drawback 1: The Succession Challenge
No one can stay in power forever. Because complete control is valuable and it can’t be recovered once it has been relinquished, giving up control is an extremely difficult decision. The primary challenge associated with absolute power is always a matter of succession.
Such transitions are often delayed until the controlling party is confident that they have established a system which will lead the company to make quality decisions on its own. At the end of the day, those in control would like to see their vision implemented so the company can remain successful after they’re gone. Sometimes this means finding a worthy successor, and sometimes it means creating lots of processes for making decisions.
But if the controlling party never reaches a high degree of confidence, then they will usually form a trust to pass down their controlling shares to future generations; this often means that their family or personal foundation will inherit control. Some famous examples of this are at Ford (the Ford family), Nike (the Knight family), and Comcast (the Roberts family). The ultimate performance of those who have simply inherited – rather than earned – control is doubtful.
Drawback 2: Lack of Representation
Another popular criticism of multi-class share structures is that they result in a lack of representation for public shareholders. By giving insiders disproportionate control, the majority of shareholders may have no influence over corporate affairs and instituting change may be next to impossible. The forced separation of ownership from control has the potential to undermine the value of the company. This can lead to a situation where the interests of public shareholders are not adequately represented, and company performance actually deteriorates over time.
While control can be used in ways that create long-term value, there are many examples of situations where it has been misused. Although Ford remains an icon of the American automobile industry, the dismal performance of the company’s common stock tells a different story. As of today (in February 2023), the price of the company’s common stock remains over 50% below its peak from nearly $35 per share in 1999. Ford’s market share has also slid from dramatically over the same period of time. That comes out to at least two decades of stagnation and relative decline.
By insulating a business from the influence of public shareholders, competitiveness may slowly degrade over time. This is especially true in cases where the company’s visionary founder is no longer present. When control has been handed down over generations, and successors have no experience building or overseeing a large company, performance may suffer. Technological innovation and company culture may decay without meaningful pressure from external market forces or internal leadership.
Activist shareholders often invest in undervalued enterprises and institute changes to fix underperformance. Typical activist objectives include:
Because these investors have experience across a number of sectors and their bottom line depends on increasing shareholder value, they have tremendous expertise in turning around failing businesses.
Instead of static and unequal voting structures, companies can take advantage of shareholder voting markets to dynamically reallocate control amongst their investors. These markets enable each investor to decide how many votes they’d like to have with their shares. Passive investors can sell their votes to generate current income (like an extra dividend), while activist investors may acquire votes to gain greater influence.
Drawback 3: Reduced Corporate Governance
Multi-class share structures may also go against high standards for corporate governance. This is because the individuals who control the company don’t have to consider the views and interests of public shareholders when making decisions. It can also lead to less independence and transparency by the company’s board of directors. Research by ISS Governance found that 52% of controlled, dual-class companies do not have an independent lead director nor an independent chair on their board. This compares with a rate of only 12% at most companies (i.e. those that aren’t controlled by one person and offer one vote per share).
The lack of an independent board can create the potential for abusive practices which may go unchecked, including:
excessive compensation packages,
increased dilution of common stockholders,
controversial related-party transactions, or
questionable hiring decisions.
This kind of self-dealing may be difficult to stop if shareholders have minimal voting power or authority to do so. And while investors may simply choose to invest elsewhere, these structures may ultimately result in the destruction of economic value due to mismanagement of power.
Conclusion
Firms with multi-class structures typically argue that these structures enable them to focus on long-term growth and innovation, while safeguarding against short-termism and complacency. This argument is valid in many cases, but it doesn’t justify every instance of unequal voting rights. If concentrated control was required for success, then it would be surprising how few of our largest companies actually have these mechanisms in place. The truth is that the most successful firms across every sector were able to get to where they are today without disenfranchising their common shareholders. Even in the technology sector, in which dual-class shares are on the rise, the likes of Apple, Microsoft, and Amazon have never implemented unequal voting rights for their stockholders.
In conclusion, multi-class share structures offer a number of benefits, such as allowing leaders to maintain control over their business, inspire confidence, and work towards long-term objectives. However, they also introduce several drawbacks like the lack of representation for public shareholders, reduced corporate governance, and succession challenges. As such, investors should carefully evaluate the impact that these structures can have on a company’s future success. Weighing the pros and cons presented here might be a useful starting point in such an analysis.