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.
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.
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.