Corporations aren't exactly democracies, but they do mostly abide by the long-established principle of allocating voting rights based on the size of a shareholder's ownership stake. One vote for each share gives the largest shareholders a proportionately large say on issues subject to shareholder approval.
In recent years, many initial public offerings (IPO) have dispensed with that custom, allowing founders to maintain control without retaining a majority stake, by owning a separate class of shares with disproportionate voting power relative to their economic interest.
Although the trend has gained momentum in recent years, it's not exactly new. For example, Alphabet's (GOOGL, GOOG) IPO in 2004 reserved for Google's founders a separate class of unlisted stock (Class B) with 10 votes per share, compared with one vote per share of the Class A common stock. The company would later use a stock split to issue Class C common stock without any voting rights.
Companies with multiple share classes have recently accounted for approximately 7% of the stocks in the Russell 3000 index, but dual-class stocks made up nearly a quarter of U.S. company IPOs in the first half of 2021.
- Common stock can be subdivided into separate share classes with distinct voting rights and economic interests.
- Founders of publicly listed companies can use a class of super-voting shares to maintain control without retaining a proportional economic interest.
- Companies with multiple share classes make up about 7% of listed U.S. stocks but a much higher proportion of recent IPOs.
- Critics say the practice entrenches managers, while supporters say it insulates companies from market pressures, allowing them to pursue long-term goals.
Common Stock Classes and Voting Rights
Common stock, also known as ordinary shares, is typically a listed company's main source of equity. The common share is a basic unit of accounting in corporate profit reports, and of voting power in board elections as well as shareholder votes on mergers and acquisitions.
Common stock is not to be confused with preferred stock—a different type of equity often paying a fixed dividend and ranking ahead of common stock but behind corporate debt in the event of a liquidation or bankruptcy.
Common stock may be subdivided into share classes with distinct voting rights (or none at all) before it is issued. Shares from different share classes often have the same economic interest in the company's underlying business and profits. At other times, different share classes represent distinct economic stakes as well.
For example, a single share of Berkshire Hathaway Inc. Class A stock (BRK.A) has the economic interest equal to that of 1,500 Berkshire Class B shares (BRK.B) and voting power equal to that of 10,000 Class B shares.
Mutual fund share classes refer to their fee structure rather than voting rights.
Rationale for Dual Share Classes
When Google went public with dual share classes, its founders cited the example of media companies using classes of shares with disproportionate voting power to insulate the companies' owners from short-term commercial pressures. The structure would make it harder for outsiders to take over or influence Google and easier for the company to focus on long-term innovation, retaining a key advantage of private companies, argued Larry Page and Sergey Brin.
The notion that the company's founder is also best able to drive its long-term success was likely helped along by the way Apple Inc. (AAPL) floundered after founder Steve Jobs left in 1985 following a boardroom power struggle, only to mount a historic comeback after Jobs returned to lead the company in 1997.
While most company founders are unlikely to replicate that success, investors in IPOs and shares of recent IPOs tend toward optimism about founders' abilities. Since share classes and their distinctions in voting or economic power are disclosed in the IPO prospectus and other securities filings, investors in such companies are presumably making an informed decision that takes any such disparities into account.
Some defenders of dual share classes with different voting powers go a step further, arguing that corporate governance measures advocated by critics of the practice amount to little more than window dressing. Stocks are ultimately priced on financial performance that has little to do with whether a founder has preserved control through a class of stock with extra voting power, they contend.
Criticism of Dual Share Classes
Critics including a group representing public pension funds and other institutional investors contend dual share classes entrench unaccountable founders and expose other shareholders to the increased risk of self-dealing and other abuses by those in charge. The Council of Institutional Investors supports proposed legislation that would require companies listed in the U.S. to have sunset provisions merging multiple share classes after a maximum of seven years unless each class of shareholders approves an exension.
The Securities and Exchange Commission's (SEC) investor advocate has called dual-class shares "a recipe for disaster" fostering management abuse of shareholder interests.
Example of Multiple Share Classes
Let's use Google and its parent entity, Alphabet as an example. The company has different share classes, notably:
- Class A shares: These shares trade on the Nasdaq under the ticker symbol GOOGL. Anyone who holds these shares has one vote per share.
- Class B shares: These shares don't trade on an exchange. They are owned by Google insiders and early investors and entitle them to 10 votes per Class B share, making them super-voting shares.
- Class C shares: This stock trades on the Nasdaq under the ticker symbol GOOG. Class C shareholders have no voting rights.
Class C shares were distributed in an April 2014 stock split that provided shareholders with a Class C share for each Class A share owned. This allowed Google (subsequently reorganized as a subsidiary of Alphabet) to offer stock compensation to employees in Class C shares without further diluting founders' control of the company.
Research has found that investors are more concerned about dual share classes when they preserve family control than in the case of companies like Alphabet. Alphabet's two classes of publicly traded stock have consistently traded interchangeably; on June 22, 2022 the Class C non-voting stock closed at a premium of less than 0.5% to the class A voting stock.