- Having voting and non-voting classes of shares is known as dual classes of shares
- Dual share classes are considered controversial by some and was even banned from 1926 to the 1980’s by the NYSE
- Sometimes non-voting shares are valued slightly less than voting shares
- Voting shares indicates owners are entitled to vote at the shareholders’ annual meetings
- Non-voting shares indicates owners are not entitled to vote at the shareholders’ annual meetings
- Classes of shares can differ in rights to dividend payments and the calculation of dividends owed
- Missing out on voting rights can be a disadvantage that reduces the value of the stock
Dual classes of shares
Ownership of stock means that you are a shareholder. Being a shareholder (or partial owner) of a company entitles you to certain rights as defined by the company at the time of the issuance of the stock. In other words, when you are buying it, they let you know how you can potentially benefit from the investment.
In some companies, all shares issued have equal rights. However, this can lead to what is referred to as the agency problem – the separation of ownership and control. Initially in a company, it is owned and run by the founders. As subsequent investments are made in the company, there are those who have an ownership interest who are not the ones controlling the day to day operations and decisions of the company. The conflict between ownership interests and controlling interests is the agency problem.
It is called a problem because there are times when the management of a company might have a focus that does not produce immediate dividends for the owners. For example, perhaps the company executives are focused on growth or on a capital-intensive development of new products leaving the cash flows of the company to be diminished. Company shareholders may be frustrated by this approach in the short-term and not stay around long enough to benefit in the long-term. Conversely, shareholders may be focused on the sustainability of a company while company executives are distracted by personal projects.
To resolve this problem, some companies have created dual classes of stocks. The classes are differentiated by whether they have voting rights and what dividends are due to them. The benefit of having a dual class structure is that it allows founders and majority shareholders to maintain control. Once this class structure is in place, they won’t have to worry about a hostile takeover or handle pressure from shareholders who don’t agree with how they are running the company. The downside of having this structure is that it diminishes the oversight of the management because there is no risk of being voted out. The other downside is that some investors will not invest in a company if they cannot have voting power so having a dual class structure effectively limits the pool of potential investors.
To be clear, it is not that owners are always right or that management is always right. Each situation warrants situation-specific analysis. As an investor when there is a dual class structure of stocks, one has to analyze whether the stock class you’re purchasing in is worth the price you’re paying – especially if you are foregoing voting rights. Usually once a dual class structure has been created, new shares cannot be issued with superior voting rights than the A (voting) class of shares. Some well-known companies that have dual class structures of shares are Berkshire Hathaway, Groupon and Google.
Traditionally, shareholder voting is one of the major rights of being a majority shareholder. As an owner, this is how you influence who is on the board of directors and have an opportunity to weigh in on major issues the board addresses. Voting provides oversight because shareholders can vote out unacceptable leaders based on their performance. Also, if enough shareholders band together, they could even take over the company if they think it should be run differently. Voting shares provide a direct mechanism for owners to impact the future growth and longevity of a company.
When trying to evaluate whether investing in non-voting shares is worth it, examine whether there is a price difference between the two classes of shares and any differences in entitlement to dividends. Typically, non-voting shares are priced between 0-5% less than voting shares – so it’s not a big difference in cost to the investor initially, however, if you are also giving up dividend payouts that is something to consider whether it’s worth investing in even if the stock price was slightly cheaper.
But the value in the long term of what effect one could have potentially had to influence outcomes is harder to estimate. Influencing outcomes is also known as “control” – this is why the agency problem is pitting the interests of owners versus control. The ability to influence control is whether an owner with a controlling interest has the ability to change the operations of the company enough to generate higher cash flows whether this change is in process, products, services or talent management.
There are two main situations in which there isn’t a major disadvantage associated with not having a voting interest and two situations where there is. The size of the disadvantage should be reflected in the price difference between the two classes of stock.
A minority shareholder in a public company isn’t disadvantaged enough to receive a major discount for their lesser voting power because they have equal access to the financial info of the company and have legal protections and still benefit from the success of the company just as the majority shareholder benefits from the cash flows of the company. Also, a majority shareholder in a well run public company even if they do have voting rights may not actually have anything to change or any way they could further improve the cash flows of the company.
A minority shareholder in a private company may be disadvantaged to the extent that the private company does not share information publicly or to lower classes of stock owners. And a majority shareholder in a private company that is not well-run could probably exercise their control to cause the company to be more well run and therefore increase cash flows (and subsequently, dividends).
Creating dual class share structures to ensure a company benefits from the high performance of the founders is considered a greater advantage than any potential disadvantage of having weaker management oversight. There is risk involved. If the founders do not run the company as well as expected, this increases the risk. In a publicly traded company, the financial information is available to all investors who can analyze whether the risk is with the reward for them. When you have purchased non-voting shares in a private company that is not required to publicly disclose financial information or perhaps to share the information with you, the risk is even greater.
When considering investing, if you are going to own more than a fractional or nominal amount of shares, the valuation analysis of whether non-voting shares are worth investing in is very important. For major stakeholders, if you have non-voting shares, you are forfeiting the present and future ability to influence the outcome of the company.