Dual-class stock: governance at edge: the edge of diminished board accountability? Or the edge of heightened management performance? Our panel debates the drawbacks and benefits.

• Author: Kristie, James
• Position: SHAREHOLDER VALUE - Discussion

WHEN GOOGLE was going public in 2004 with a dual-class share structure, in which the Class A common stock being offered would have one vote per share while a Class B common stock held by management and existing shareholders had 10 votes per share, the company advised potential new investors thusly:

"Google has prospered as a private company. We believe a dual class voting structure will enable Google, as a public company, to retain many of the positive aspects of being private. We understand some investors do not favor dual class structures. Some may believe that our dual class structure will give us the ability to take actions that benefit us, but not Google's shareholders as a whole. We have considered this point of view carefully, and we and the board have not made our decision lightly. We are convinced that everyone associated with Google--including new investors--will benefit from this structure. However, you should be aware that Google and its shareholders may not realize these intended benefits."

This was a remarkably forthright 'heads up' to potential shareholders. Google has subsequently followed up its successful IPO appearance as a dual-class company with a proposal earlier in 2012 to issue a new class of non-voting stock that would further consolidate management's control--or, "complete chokehold," as critics like Reuters Breakingviews news service called it--of the company. And coming to market within the past year with a dual- or multiple-class structure have been such hotly anticipated (at the time of their IPO) tech companies as Facebook, Zynga, Groupon, and LinkedIn. The spotlight on dual-class stock is not reserved just for technology IPOs. The high-profile U.K. sports organization Manchester United went public on the New York Stock Exchange with dual-class shares in July 2012 as this article was being prepared for publication, and a dual-class ownership structure has been a sore point for shareholders of the Rupert Murdoch-dominated News Corp., especially since the hacking scandal broke last year.

Financial Times columnist Andrew Hill perhaps best formulated the conundrum facing any analysis of dual-class stock: "The advantage of a dual-class share structure is that it protects entrepreneurial management from the demands of ordinary shareholders. The disadvantage of a dual-class share structure is that it protects entrepreneurial management from the demands of shareholders."

Is there any reconciling the conflicting sentiments and analyses? In April 2012 Charles Elson convened a panel at the University of Delaware's Weinberg Center for Corporate Governance to examine the tradeoffs of dual-class stock. The panel was a smartly composed mix from the corporate and legal sector, the media, academia, and the institutional investor community. (This is the fifth in a series of roundtable collaborations that DIRECTORS & BOA.RDS has done in conjunction with the Weinberg Center of Governance over the past dozen years.) Highlights of the panelists' spirited debate follow.

Charles Elson: You're exporting the monitoring function

Charles Elson is the Edgar S. Woolard Jr. Chair in Corporate Governance and director of the Weinberg Center for Corporate Governance at the University of Delaware. He has served on several corporate boards, including a present directorship on the HealthSouth Corp. board. He is a member of the DIRECTORS & BOARDS editorial advisory board.

Our legal system of governance has traditionally been predicated around the notion of voting control based on one share, one vote--the idea being that if you didn't like what managers were doing you could vote them out. But a dual-class structure is an odd exception to this typical formula, and it raises all kinds of legal issues, particularly about the obligations of the controlling shareholder to the other shareholders.

One view of dual-class stock is that the only ones potentially being harmed are those that invest in a company with a dual-class structure. After all, they don't have to make that investment. It you read the Google IPO document it has a very explicit warning about its having a dual-class structure and that investors may not be happy with the ramifications of that.

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But are the harms limited only to the shareholders? Are the harms actually much broader, much more societal-based? Where you have dual-class stock, the controlling shareholder controls the board. Though having legal responsibilities to oversee management and monitor effectively, the board, practically speaking, becomes much less of a monitor. Instead, what you're doing is exporting the monitoring function to third parties--to the government, the courts, the regulators. That then creates a significant public cost. In the end, when there is a problem and someone has to clean up the mess that maybe a beholden board has not caught, the damage isn't just limited to the shareholders. The damage is to society in general and the public pays for it.

The debate over dual-class share ownership is moving beyond the notions of board accountability impacting cost to the individual investor to a wider economic rationale based on cost to the public.

Ann Yerger: Fundamentally flawed as a long-term capital model

Ann Yerger is executive director of the Council of Institutional Investors. The Council is an organization of more than 140 public, corporate and Taft-Hartley pension funds that manages over $3 trillion in assets. She joined the Council in 1996 and was named to her present position in 2005.

The Council of Institutional Investors opposes dual-class stock structures because we are opposed to unequal voting rights. While dual-class structures may seem attractive when brilliant founders are running the entity, we believe the structure is fundamentally flawed as a long-term capital model.

The Council has long believed that when it comes to public equity markets voting power should be proportional to the economic interests of the holders. When the Council formulated its bill of rights after it was formed in 1985, the first provision was "one share, one vote." The vote is very important. It's a tool for holding management accountable and having a say on major issues.

You have to remember that not all investors are actively selecting their equities. Some equities are owned because they're part of broader indexes, like the Russell 3000, which have a number of dual-class companies in them--Google, Comcast, Ford, News Corp., New York Times Co. Council members are heavy users of passive strategies and can't simply exercise the Wall Street Walk and sell if they're unhappy with management.

The argument that a dual-class stock is priced at a discount--so, "no harm, no foul"--is of no solace for us when the company may hit hard times, or when second generation of leadership isn't doing the same excellent job that the first generation has been doing. Council members want boards that are empowered to actively oversee management and to make course corrections when appropriate. When directors essentially can be hired or fired by a single person or a family makes it difficult for directors to exercise fully their legal duties to act in the best interest of all shareholders.

Finally, to those proponents who argue that the structure promotes longterm thinking which is in the best interest of the company and its shareholders, let me make this observation. Clearly...