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Dual Class Shares – Definition

Dual Class Shares Explained

Some companies issue two types of shares in the market, each type having different rights attached to it. For example, the shareholders with preferred stock are generally entitled to receive a guaranteed dividend; but, they often lack voting power in company’s decision-making process. Common shareholders, on the other hand, are allowed to receive a dividend only after the preferred shareholder receive theirs. These shareholders, however, have the right to vote during the annual meeting of the company.

A Little More on Dual Class Shares

Dual class shares are generally issued by the companies for retaining the power of decision making within the circle of founders, executives, and families. One class of stocks are issued in public which lacks the voting power while the other class is offered only to the executives and family members.

It allows the company’s founders and executives to control majority voting power with a comparatively small percentage of total shares. Like in Ford the Ford family owns only 4% of the total equity but it has the 40% voting power in the company. They could retain this much power with such a small amount of equity percentage only because they issued two classes of stocks. Another example is Echostar Communication’s CEO, Charlie Ergen. He holds only 5% of the total equity but has 90% voting control.

Google also issued second-class B shares only to its founders having 10 times more power in voting than the ordinary class A shares.

U.S. companies can enlist dual-class voting shares on the New York Stock Exchange, but the companies are not allowed to withdraw the voting rights of a class after it is listed. Also, they cannot introduce a new class of shares with greater voting rights after getting listed.

The dual class stock structure has sparked controversy as some believe it is an effective way of managing a business with a strong leadership potential, while others argue in this system a small section of people with greater voting power control the company’s management and operations and other shareholders supply the majority of the capital. They also believe this system doesn’t go well with market capitalization.

References for Dual Class Shares

Academic Research on Dual Class Shares

Relative prices of dual class shares, Smith, B. F., & Amoako-Adu, B. (1995). Journal of Financial and Quantitative Analysis30(2), 223-239. This study uses data from the Toronto Stock Exchange to show that the price premium of superior voting share (SVS) over restricted voting shares (RVS) reflects the expected premium paid to shareholders outside the control block. This study confirms other empirical studies indicating that SVS sell at a premium compared to counterpart RVS.

Corporate groups, dualclass shares and the value of voting rights, Nicodano, G. (1998). Journal of Banking & Finance22(9), 1117-1137. This article examines the premiums that arise by using voting systems other than the traditional one-share-one-vote system. The empirical study confirms that the voting-share premium is larger for firms with a business group or holding companies issuing non-voting stock when compared to those with non-voting equity.

Stock pyramids, cross-ownership, and dual class equity: the mechanisms and agency costs of separating control from cash-flow rights, Bebchuk, L. A., Kraakman, R., & Triantis, G. (2000). In Concentrated corporate ownership (pp. 295-318). University of Chicago Press. This paper examines an unusual situation in firm ownership in which a shareholder exercises control while retaining only a small fraction of equity claims on a company’s cash flows. The conditions that lead to such a situation, along with the control, structure, and incentive complications are further analyzed.

Dual-class shares: a review, Rydqvist, K. (1992). Oxford Review of Economic Policy8(3), 45-57. This paper offers a broad overview of dual-class shares. The information provides a background of this particular investment vehicle, and an explanation as to why it’s not traded in every market. This article is an excellent introduction to the topic and useful for beginners or anyone not familiar with dual-class shares.

Determinants and consequences of the unification of dualclass shares, Pajuste, A. (2005). Many firms in Europe are turning away from the dual-class shares system, and this paper explores the reason for this change. An increasing number of firms are moving their shares towards a single class. The data used in this study shows that firm values tend to increase after reunification.

The use of accounting information for the valuation of dualclass shares listed on China’s stock markets, Chen, G., Firth, M., & Kim, J. B. (2002). Accounting and Business Research32(3), 123-131. This study examines the accuracy of accounting data in explaining the market value of listed firms in China. Dual-class shares where domestic investors and foreigners hold different share classes are the focus of the investigation. The findings help clarify the earnings information and book values of these companies. Implications for the future are also considered.

Mispricing of dualclass shares: Profit opportunities, arbitrage, and trading, Schultz, P., & Shive, S. (2010). Journal of Financial Economics98(3), 524-549. This paper shows how small price discrepancies in the prices of dual-class shares with equal cash flow rights can result in abnormal profits and transaction costs. Simple trading strategies can allow investors to exploit these gaps, but long-short arbitrage can offer a minor solution to eliminate those gaps.

Canada’s dual class shares: Further evidence on the market value of cash dividends, Bailey, W. (1988). The Journal of Finance43(5), 1143-1160.

Empirical results show that following the Canada Income Tax Act of 1971, the premium paid on cash-paying equity shares is explained by the relative value of dividends paid minus the costs imposed on the shareholders. The findings also show that there is no evidence to suggest that investors prefer cash income to an equal amount of capital gains.

Dual-class shares and audit pricing: Evidence from the Canadian markets, Khalil, S., Magnan, M. L., & Cohen, J. R. (2008). Auditing: a journal of practice & theory27(2), 199-216. This study investigates the relationship between audit fees and the cash flow/control rights situations that follow dual-class share structures. Additionally, the authors seek to find if a director’s independence and presence of institutional block-holders moderates this association. The authors suggest that the existence of dual-class shares will affect audit fees as the demand of assurance services rises.

Agency problems at dualclass companies, Masulis, R. W., Wang, C., & Xie, F. (2009). The Journal of Finance64(4), 1697-1727. This study illustrates the divergence between insider voting and cash flow rights as they relate to managerial extraction of private benefits of control. By using a sample of U.S. dual-class companies, the authors show that managers with greater excess control over cash flow rights are more likely to pursue private benefits at the shareholder’s expense. This also helps to explain how a firm’s value can drop in a situation where an insider has excess control rights.

Long term changes in voting power and control structure following the unification of dual class shares, Lauterbach, B., & Yafeh, Y. (2011). Journal of Corporate Finance17(2), 215-228. This study looks at the effects of a regulatory change in Israel during the 1990s that caused the unification of most dual-class shares. A sample of 80 companies that unified their dual-class shares are followed, and these companies are compared with a control sample of firms that kept the dual-share structure until at least the 2000. The findings show that shareholders that their shares unified made up the loss of voting rights by buying more shares before and after the unification. The study also found that those firms which chose to unify their shares didn’t show a substantial improvement in performance and valuation.

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