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Double trouble – There is nothing equal about dual-class share structures

Home / EOS articles / Double trouble – There is nothing equal about dual-class share structures

Christine Chow,
18 December 2015
Governance

Q3 2015

We promote the principle of one-share one-vote and push for equal shareholder rights at companies where dual – or multiple share structures are the norm. We also press for strong safeguards to be in place wherever there are such structures.

Hermes EOS view
Our view is that equal voting rights should be attached to shares regardless of the total holding or other characteristics of an investor. We therefore promote the principle of one-share one-vote, which ensures proportionality between equity ownership and voting powers, and thus economic risk-bearing. Any divergence from one-share onevote can have a disenfranchising effect on minority shareholders, which is why we do not support multiple-class share structures when engaging with companies. While we are in favour of encouraging longterm investment, we oppose the measures recently taken in France and Italy.

Europe
In France, the Florange Act – which was adopted in March 2014 – seeks to reward long-term investment by granting double-voting rights to shareholders registered for a continuous 24-month period. Unless companies opt out by amending their articles of association, this provision will apply from April 2016.

Due to the strengthening of large block shareholders over the interests of minority shareholders, the process effectively disadvantages international institutional investors. In our view, the mechanisms of the Florange Act will therefore not achieve the objective of long-term investment in a fair and equal manner.

We have systematically engaged CAC40 companies regarding the dilution of shareholder rights as a result of the Florange Act, urging them to maintain their current application of one-share one-vote or reconsider the implementation of double voting rights and reinstate the principle of one-share one-vote. So far, only 12 of the CAC40 companies have chosen to include one-share one-vote in their articles. Some companies are reluctant to opt out of the Act, particularly where double voting rights existed prior to the Florange Act, as they claim they are working well.

Italy introduced legislation on loyalty shares in 2014, whereby companies may opt into double voting rights rather than opt out like in France. Italian listed companies can grant double voting rights to shareholders who have held their shares continuously for at least two years. The Italian government passed a resolution in July 2014 lowering the majority requirement from two thirds to half the votes cast for companies wanting to change their by-laws to implement loyalty shares. This caused significant concern given that, according to the Italian regulator CONSOB, approximately 70% of Italian listed companies are majority-controlled.

Hermes EOS voted against loyalty share proposals at AGMs in 2014, and in 2015 we co-signed a letter sent to a selection of listed Italian companies, urging them to maintain the principle of one-share one-vote.
Pressure from institutional investors and non-executive directors at major Italian companies helped stop the extension of the simple majority rule, which expired at the end of January 2015.

The initial draft of the revision of the EU Shareholder Rights Directive contained suggestions for loyalty shares. Following our intensive lobbying and that of other investors expressing concerns, these suggestions were dropped in the final draft text, as EU member states would have been required to implement similar rewards for shareholders to those envisaged by the Florange Act, reducing the attractiveness of European companies as investments and disadvantaging shareholders.

Hong Kong
But multiple-class share structures rights are not just limited to European companies. They have become a contentious issue in Hong Kong of late1 although the listing of companies with multiple class share structures has not been practice at the Hong Kong Exchanges and Clearing (HKEx).

In August 2014, in light of increasing2 listings by Mainland Chinese companies with multiple-class share structures in the US, particularly against the backdrop of the initial public offering of Chinese e-commerce giant Alibaba with a partnership structure on the New York Stock Exchange, the HKEx published a concept paper to explore the idea of multiple-class share structures.

In June 2015, it published a summary of the responses it received to the paper, recommending to allow primary listings with multipleclass share structures that may potentially adhere to some of the following features:

1) In terms of size: Companies eligible for multiple-class share structures should have a large market capitalisation, such as a high minimum valuation

2) In terms of structure, companies should have:

  • Sunset clause – the loss of superior voting rights at a pre-set future date
  • „„Continued active involvement of the founder
  • „„Restriction on transfers„
  • Cap on votes per share„
  • Shareholder vote – the loss of superior voting rights after a vote by independent shareholders
  • „„Minimum equity threshold held by founders or others„
  • Board structure with a greater proportion of independent non-executive directors
  • „„Be allowed for secondary listed company if the company is already listed in a market with credible regulatory standards.

We believe that specifying the size of the company poses significant
risk to institutional investors because companies with large market capitalisation are highly likely to be included in market indices.
Investments that use market indices as benchmarks and passive funds instruments are therefore most exposed to multiple-class share structures. Passive investments are obliged to buy, and most likely hold, the stock.

We acknowledge that investors may benefit from founders’ value that is significant for a growing company, including value that is realised by granting companies the ability to manage short-term investors who seek to reap gain at the expense of long-term growth of the company.3

But Hong Kong’s Securities and Futures Commission (SFC) unanimously rejected the HKEx’ proposal to allow companies with multiple-class share structures to list in certain circumstances a week after the HKEx published its proposal. The SFC had concerns about regulators having to assess compliance with the criteria for companies to be eligible for multiple-class share structures, such as the contribution of the founder/s. It argued that these criteria can only be applied subjectively and are therefore inherently vague. The SFC also argued that Hong Kong’s securities markets and reputation would be harmed if these structures became commonplace.

The HKEx has since suspended the second consultation on the issue.

We propose that ordinary shareholders should be entitled to vote for or against the multiple-class share structure on a regular basis, irrespective of retirement or disassociation of the founders from the company, with equal participation from shareholders with different share classes. The key difference of our proposition here versus that of the HKEx is that multiple-class share structures are not a structure that shall be maintained, but a transition arrangement that needs to be voted for periodically to justify a misaligned structure due to the interim benefits it brings. Ongoing stewardship is therefore necessary to maintain sound corporate governance and the protection of minority shareholders when companies – albeit temporarily – deviate from best practice in order to benefit from the upside potential of multiple-class share structures.

US
Dual class shares structures also exist in the US. We have been engaging with media company Twenty-First Century Fox on this issue. Its dualclass share structure gives founder Rupert Murdoch and his family control of more than 40% of the voting power, despite his relatively modest 12% economic stake in the company. When the publishing and book businesses were spun off from the TV and film segments in June 2013 under the name ‘News Corp’, the same dual-class share structure was incorporated into the new entity, preserving the significant governance risk associated with the brand prior to the spilt.

At News Corp’s first annual meeting in 2014, we introduced a shareholder proposal calling for an end to this arrangement which received 90% support from independent investors. We were disappointed that the board chose to ignore this resounding message sent by investors by refusing to engage in meaningful dialogue to explore possible alternatives. Building on the overwhelming support from independent investors, we again filed a shareholder proposal at News Corp calling for the elimination of the dual-class share structure in 2015. We believe that the implementation of our 2015 proposal would reduce business risks at News Corp and Twenty-First Century Fox and help make the boards more responsive to the interests of all shareholders and permit greater scrutiny of management. After the presentation of our shareholder proposal in the fourth quarter of 2015, we will keep pursuing the board to enter into meaningful discussions.

Overall, we will continue our engagement with policy-makers and companies to ensure an optimum outcome for our clients and investors.

  1. 1 In Hong Kong, multiple-class share structures are referred to as weighted voting rights
  2. 2 For example, nine of the 12 Mainland Chinese companies to primary list on a US exchange in 2014 adopted a multiple-class share structure.
  3. 3 Tech Firms Seek Ways to Fend Off Activist Investors, Ovide and Clark Wall Street Journal 26 May 2015, Why Activist Investors are Targeting the Tech Industry, Griffith Fortune 21 July 2015.
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Christine Chow Dr Christine Chow is responsible for the financial services, technology and extractive sectors in Asia ex-Japan. She has 19 years of experience in portfolio management, research and investment consulting. Christine's PhD thesis on shareholder engagement for responsible investment was short-listed for a UN award in Sweden for industry relevance and academic excellence. She is an adjunct associate professor in the Department of Finance at the Hong Kong University of Science and Technology. She is a governor of the London School of Economics and a member of the university’s investment committee. She was also a member of the greater China committee of the Hong Kong Retirement Funds Association between 2014-2016. Christine has worked at a number of multinational corporations such as Merrill Lynch, Schroders and Hewitt. In the 1990s, she was responsible for establishing strategic partnerships in fund management for the Schroders Group, especially in Mainland China. Christine is a graduate of the London School of Economics and the University of Melbourne. She also completed an executive education course on financial engineering at Stanford University.
Read all articles by Christine Chow

Setting the scene
Dual- or multiple-class share structures are based on the idea that not all shareholders are equal. This means that some shareholders hold disproportionate voting power in relation to the shares that they own. The complexities and costs involved in share registration where multiple-class share systems are in place, the limitations on eligibility for some shareholders given the different fund and holding structures and a potential lack of understanding of the system create a disadvantage for international investors. This is often the case where companies still have their founder in an influential position and it has recently occurred at the initial public offerings of Alibaba and Facebook. In France and Italy, the regulator has promoted dual-share structures in an attempt to reward long-term investors. As a result, many of our clients are invested in companies with multiple class share structures.

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