When I was in my teens, the Canadian government produced a book detailing inter-corporate ownership in Canada. It's still available today. Its pages laid out some extremely labyrinth-like ownership structures, which holding companies used to control vast empires. I found them fascinating and still do.
Unfortunately, fewer companies use the dual-class structure now because of a misguided belief that they reduce corporate governance for other shareholders. However, similar to prescription drugs, how people use them directly affects the results they achieve. Dual-class shares in the hands of visionaries can produce tremendous long-term results. In the hands of the power hungry, however, they can be a ticking time bomb. (Find out how dual-class shares can affect a company's performance. Check out The Two Sides Of Dual-Class Shares.)
Pros And Cons
Two major studies highlight the arguments for and against dual-class share structures. Duke University professors Linda Vincent, Jennifer Francis and Katherine Schipper did a study from 1990-99 examining 205 dual-class companies and 5,764 single-class ones. The perception is that dual-class stocks produce less-reliable earnings than their single-class counterparts. On the flip side, dual-class shares provide a greater consistency of dividend payments. In fact, they found that 59% of dual-class stocks paid dividends compared to 28% of single-class companies. Despite institutional criticism, it's no wonder dual-class stocks had greater ownership by those same critics. Their returns were higher.
Another study, "Extreme Governance: An Analysis of Dual-Class Firms in the United States", this time by professors at Wharton (Andrew Metrick), Stanford (Jpy Ishii) and Harvard (Paul Gompers), looked at dual-class stocks between 1995 and 2002. This study found that where voting rights exceeded economic rights, it was bad for the other shareholders. As an example it noted Ford (NYSE:F) stock generates 15% lower returns due to its dual-class structure. This was before its fall into the Big Three abyss.
Winners And Losers
For every example of their misuse – Ford and The New York Times (NYSE:NYT) – there are plenty of winners. Marc Andreessen, founder of Netscape, has a blog that talks about technology. In a post from May 6, 2008, he discussed his conversion from dual-class hater to dual-class supporter. Originally Andreessen, like most opponents of this type of ownership structure, felt that one share meant one vote. However, upon reflection, Andreessen switched sides, emphasizing that a dual-class structure can help founders build a long-term franchise without worrying about who will make the decisions should it raise additional capital. In his defense, he used the Washington Post (NYSE:WPO) and Google (Nasdaq:GOOG) as examples of companies that work because of this structure, not in spite of it. I couldn't agree more. Who knows a business better than its founders?
Nike Just Does It
Take Phil Knight and Nike (NYSE:NKE). Founded by Knight in 1968, the swoosh rules sporting goods. As of July 25, 2008, it had 96,191,444 Class A shares and 394,220,937 Class B shares outstanding. Each entitled to one vote, Class A shareholders elect nine directors and Class B shareholders elect three. Knight owns 91,910,094 Class A shares, or 95.5% of the class, and 91,923,764 Class B shares, or 18.9%. Knight controls the election of a majority of directors with 37.5% of the equity. That's not insignificant. It's a lot more than the 3.5% equity stake the Agnelli family held in Fiat in 2006, giving it (through a number of holding companies) control of 30.3% of the votes.
Nike's results speak volumes. Over the past four fiscal years, Nike has grown revenues and earnings per share on an annualized basis of 10.9% and 20.9%, respectively. During this time, its stock appreciated 19.33% annually compared to 5.73% for the S&P 500. The dual-class structure obviously didn't hurt Nike. Approximately 6% of U.S. companies are dual-class. I hope more will come.
For more, read our answer to the investment question Why would a company have multiple share classes, and what are super voting shares?