Sticking around Too Long? Dynamics of the Benefits of Dual-Class Voting
Both practitioners and academics generally have a dim view of dual-class share structures. For example, when Snap Inc. was preparing for its initial public offering (IPO) in 2017, CalPERS and other institutional investors harshly criticized the company’s move to create a new share class with no voting power. Similarly, before Lyft went public this year, a group of institutional investors urged its board to abandon a proposed dual-class structure. The main drawback of a dual-class share structure, as academics argue, is that insiders who control the firm with disproportionate voting rights relative to their cash flow rights can easily take advantage of dispersed outside shareholders.
Despite the criticism and disadvantage of the dual-class structure, IPOs of many prominent companies, especially in the high-tech sector (such as Google, Facebook, and Lyft) have adopted dual-class voting. This observation is what led us to look more closely at the potential benefits of that structure, particularly over firms’ life cycles. In our paper, ‘, we examine how the benefits of dual-class share structures, net of costs, evolve over a firm’s life. We carefully (often manually) construct a database of more than 900 unique dual-class firms in the United States over almost 50 years, from 1971 through 2015. Using the data, we show that young (i.e., younger than the 12-year median age of firms in the sample since their IPOs) dual-class firms have about 7% greater valuation relative to single-class firms of the same maturity, in the same industry and year, and with similar characteristics. However, as they mature, dual-class firms experience approximately 9% greater declines in valuation than do single-class firms. Further analyses find that deteriorating operating performance, pace of innovation, and increasing systematic risk are behind this declining valuation of the dual-class structure over time.
The evidence in our paper thus suggests that the costs of a dual-class share structure increase significantly when firms mature, while the benefits of shielding firms from capital market pressure appear to decrease. Our findings challenge the dominant view that dual-class voting is suboptimal. Rather, dual-class voting is likely to be optimal for young, fast-growing firms. Thus, we argue that rather than precluding dual-class firms altogether, investors and firms are better off by permitting these structures but tying them to sunset provisions. Such provisions would set an event (such as passing of a fixed period of time) that automatically ends the structure, or give minority shareholders a vote determining an extension of the structure at a predetermined time post-IPO. These provisions are simple to understand and implement, and would allow firms and investors to enjoy the advantages of a dual-class structure when there are clear benefits (e.g., when firms are young and growing fast), while providing a time-consistent way to end this structure when ‘the time is up’.