In General, What Advantages and Disadvantages Do You Attribute to a Dual-Class Ownership Structure? When And/or for What Types of Firms Is Such a Structure Most Appropriate?

1. In general, what advantages and disadvantages do you attribute to a

dual-class ownership structure? When and/or for what types of firms is such

a structure most appropriate? Least appropriate?

Dual-class ownership structures typically involve two or more classes of common stock with different voting rights. They occur in many countries and often permit a family or other group of insiders to maintain control of a corporation that has issued a substantial number of common shares to public investors. They are also commonly used to ensure local (i.e., home-country) control of global enterprises with substantial numbers of shares held by foreign investors and/or listed on foreign exchanges

Dual class shares are common outside the United States. Ownership structures in Europe and Asia often involve pyramidal control of a group of companies by a single family. In these situations, the controlling family has many opportunities for expropriation of minority shareholders through tunneling. Dual class shares with differential voting rights allow a controlling shareholder or family to maintain control of a company or group even if their cash flow rights are relatively small.

Any discussion of corporate governance—the system of controls, regulations, and incentives designed to prevent fraud—is a story of conflicts of interest and attempts to minimize them. When those interests diverge, we may have agency conflicts.

Dual-class structures have long attracted criticism for being potentially unfair to some shareholders and generally inconsistent with good corporate governance. They were prohibited, for example, by the New York Stock Exchange’s listing rules for most of the 20 th century. The NYSE’s traditional insistence on “one share, one vote” was relaxed in the mid-1980s under pressure from listed companies concerned about hostile takeovers. In 2010, prominent U.S. companies with dual- class shares included, for example, Ford Motor, New York Times, MasterCard, VISA, Berkshire Hathaway, Blackstone and Google.

Much of the focus in the United States is on the agency conflict between shareholders,

who own the majority of a firm but are a dispersed group, and managers, who own little of the firm and must be monitored. In many other countries, the central conflict is between what are called “controlling shareholders” and “minority shareholders.” In Europe, many corporations are run by families that own controlling blocks of shares. For most practical purposes, blocks of shares in excess of 20% are considered to be controlling, as long as no one else has any large concentration of shares.

In these firms, there is usually little conflict between the controlling family and the management (it is often made up of family members). Instead, the conflict arises between the minority shareholders (those without the controlling block) and the controlling shareholders.

There is an opportunity cost to bad governance; thus, by replacing bad governance with good governance, it is possible to increase firm value—in other words, good governance is a positive-NPV project. Hence, we begin by discussing various governance mechanisms that are designed to mitigate the agency conflicts between managers and owners.

We discuss the types of advantages and disadvantages in general for a dual-class ownership structure and when is such a structure most appropriate of less appropriate.

Pros:

• They argue that they need to maintain control to protect editorial integrity.

• They reason that dual class structures allow their companies to remain committed to serious news coverage, even when short-term results are fluctuating and shareholders, focused on financial matters, might seek to change the composition of the board or management.

• The idea is that if you own 20% and the other 80% is dispersed among many different shareholders, you will have considerable say in the operation of the firm; other shareholders would have to coordinate their activities to try to outvote you—a formidable challenge.

• The founders of these companies argue that their strong control position gives them a continuing incentive to build the desired brand equity, which translates into a strong market position and profitable stock returns. Employee-owned companies similarly fi nd advantages in dual class structures. They take the position that by enabling employees to own the majority of company stock, the dual class structure creates a positive corporate culture with high employee morale and increased productivity. The company’s management can reap the benefi ts of going public without undermining this positive culture.

• The founders of these technology companies reason that they have a dynamic, long-term vision for the company. They need to retain control in order to continue to innovate and remain an industry pioneer. Short-term market forces and risk-averse shareholders should not dictate or interfere with the founders’ vision. Relatedly, the founders reason that dual class structures provide a strong takeover defense, keeping the company on track to achieve their long-term objectives.

• Dual Class Shares and the Value of Control. One way for families to gain control over firms even when they do not own more than half the shares is to issue dual class shares—a scenario in which companies have more than one class of shares and one class has superior voting rights over the other class. For example, Mark Zuckerberg controls more than 50% of the voting power of Facebook because he controls the majority of Facebook’s class B shares, and these shares have ten votes for every one vote of a class A share. Controlling shareholders—often families—will hold all or most of the shares with superior voting rights and issue the inferior voting class to the public. This approach allows the controlling shareholders to raise capital without diluting their control.

Cons:

The conflict of interest between managers and investors derives from the separation of ownership and control in a corporation. the separation of ownership and control is perhaps the most important reason for the success of the corporate organizational form. Because any investor can hold an ownership stake in a corporation, investors are able to diversify and thus reduce their risk exposures without cost. This is especially true for the managers of a corporation: Because they are not also required to own the firm, their risk exposures are much lower than they would be if ownership and control were not separate. Once control and ownership are separated,