October 3, 2013 8:27 am

Exchanges divided by dual-class shares

Charles Li, chief executive officer of Hong Kong Exchanges and Clearing Ltd©Bloomberg

Charles Li, chief executive officer of Hong Kong Exchanges

Mr Tradition, Mr Innovation, Mrs Practical and Ms Future sound like characters from the card game Happy Families. In fact, they feature in a blogpost from Charles Li, head of the Hong Kong Stock Exchange, after the exchange refused to accommodate Alibaba’s desire for a board control structure to get around its ban on dual-class shares.

Mr Li’s musings have put centre stage the balance that many exchanges must strike in weighing their desire to attract new listings – Alibaba would have been a $60bn-plus Hong Kong company – with providing safeguards for outside investors.

Dual-class shares are a case in point. Hong Kong and Singapore are among the exchanges that ban them. The UK discourages them to the point of extinction, although they were in vogue during the 1960s. In continental Europe they are allowed, while in the US the structure has become de rigeur for the hottest tech initial public offerings, from Facebook and LinkedIn to Zynga and Groupon.

Historically, the rise of dual-class shares was a response to corporate threats. Colin Mayer, Peter Moores professor of management studies at the Saïd Business School in Oxford, says they were used by UK companies in the 1960s to protect themselves from hostile takeovers, before institutional investors marshalled their opposition to such structures. Similarly, the advent of corporate raiders in the US during the 1980s prompted the New York Stock Exchange to lift its ban on the structure in 1988, as it feared that otherwise companies such as General Motors would desert it.

Arguments for dual-class shares go beyond a defence against an opportunistic attack.

Fans say that US newspaper barons who floated their businesses in the second half of the 20th century used the structure to protect the editorial integrity of their properties from outside shareholder pressure. Such shareholdings survived even the controversy that has attached to Rupert Murdoch’s media empire, though Twenty-First Century Fox faces a challenge to the family’s effective control later in October.

Enthusiasts also argue that dual-class shares allow entrepreneurs to bring their ideas to the public market at an early stage, and enable companies to plan for the long term.

“The people behind companies such as Google, LinkedIn and Facebook say it is important to them to be able to maintain their vision and values and retain a long-term perspective,” Mr Mayer says. ”That same argument runs among families in continental Europe which use this structure.”

He says that dual-class shares also permit a company to pursue different dividend policies for different classes of shareholder. “Family shareholders might prefer to invest for the long term, while outside investors might be more concerned about immediate financial returns.”

Dual-class shares should also be more transparent than some other mechanisms through which an investor seeks control of a company without owning more than half of the equity.

In Italy, for example, Telecom Italia was a prime example of the use of pyramid structures which allow an entity with relatively little capital to control a company through various layers of intermediaries.

The essential argument against dual-class shares boils down to fairness: there should be no second-class investors, at the mercy of those who own no more of the company than they do but have greater rights. “The UK market believes in the principle of ‘one share, one vote’ even if that trumps efficiency,” says Julian Franks, a professor of finance at London Business School.

One-share-one-vote proponents also say that dual-class shares prevent investors in general from acting as stewards of the company; and remove spur to management performance provided by the risk of being taken over.

So contentious are dual-class shares that there is significant opposition to the prevailing culture both where they are allowed, and where they are banned.

In the US, for example, some investors have long grumbled about them, even while there are few signs they are prepared to boycott such companies.

Philip Larrieu, investment officer in the corporate governance office at the California teachers’ pension fund, says the founders of tech companies have surrounded themselves with too many protections.

“They put in these defences . . . managements seem to want them all,” he says, “and when they get to a size where they don’t need them, they don’t want to get rid of them.”

In the UK, meanwhile, there are various ideas for broadening the types of share on offer while protecting investors from exploitation.

“You might want restrictions on the two classes – such as setting limits on the proportions of voting and non-voting shares, or providing a sunset clause so that they die out after a set period of time,” says Mr Franks.

The momentum in the discussion is most apparent in Asia. Alongside Mr Li’s call for a debate, Singapore is considering whether to relax its ban on dual-class shares, in pursuit of its push to become, as one corporate lawyer puts it, “a home for tech and biomedical start-ups”.

One way or another, dual-class shares will provide plenty of material for arguments between Mr Competition and Mr Shareholder-Protection.

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