The Quality of Information Provided by Dual‐Class Firms

• Date: 01 October 2020
• Author: Amos Baranes,Rimona Palas,Dov Solomon
• DOI: http://doi.org/10.1111/ablj.12167
• Published date: 01 October 2020

American Business Law Journal

Volume 57, Issue 3, 443–486, Fall 2020

The Quality of Information Provided

by Dual-Class Firms

Dov Solomon,*Rimona Palas** and Amos Baranes***

When Google went public with a dual-class capital structure in which shares

owned by the founders confer greater voting rights than shares issued to public

investors, its cofounders, Larry Page and Sergey Brin, promised to provide inves-

tors with high-quality information about the company. Using the words of Warren

Buffett, the chairman and CEO of Berkshire Hathaway, another dual-class firm,

they promised shareholders, “We won’t ‘smooth’ quarterly or annual results: If

earnings figures are lumpy when they reach headquarters, they will be lumpy when

they reach you.” Page, Brin, and Buffett definitely understood the importance of

quality information to their investors, especially in dual-class structures. But do

dual-class companies really provide investors with credible financial information?

Contrary to the assumption of agency theory that dual-class firms are less transpar-

ent, we find empirically that these companies do provide credible information to

their investors. Our results suggest that the quality of financial reports, as mea-

sured by their ability to predict change in future earnings, is higher for dual-class

companies than for their single-class counterparts. These findings may be

explained by the unique relations created in dual-class firms in which the founders

provide investors with higher-quality information in exchange for superior voting

rights. The article contributes to the heated debate about the transparency of

*Dr. Dov Solomon is an Associate Professor of Law and head of the Commercial Law

Department and the LL.M. program at the College of Law and Business, Ramat Gan L aw

School. He served as a visiting scholar at the Harvard Law School Program on Corporate

Governance and the University of Michigan Law School. This article has been accepted for

presentation at the American Law and Economics Association (ALEA) 2020 annual meeting,

the European Association of Law and Economics (EALE) 2020 annual meeting, and the

Accounting, Economics, and Law 2020 annual conference of the Society for the Advance-

ment of Socio-Economics (SASE). The authors would like to thank Uri Benoliel, Lisa Bern-

stein, John Shahar Dillbary and Kobi Kastiel for their insightful comments and discussions.

**Dr. Rimona Palas is head of the Accounting Department at the College of Law and

Business.

***Dr. Amos Baranes is head of the Information System Program at the Peres Academic

Center.

©2020 The Authors

American Business Law Journal ©2020 Academy of Legal Studies in Business

443

dual-class companies by providing policy makers with important insights on the

quality of information provided by these companies. Our findings suggest that

there is no need for stricter regulation with regard to disclosure of financial infor-

mation by dual-class firms.

INTRODUCTION

When Google went public with a dual-class structure in which shares

owned by the founders confer greater voting rights than shares issued to

public investors, its cofounders, Larry Page and Sergey Brin, wrote a let-

ter to shareholders explaining their plans and the reasoning and values

behind them.

1

To appear trustworthy, they promised to provide inves-

tors with high-quality information about the company. Page and Brin

spelled out in their letter that they “intend[ed] to take steps to help

ensure shareholders are well informed.”

2

Moreover, they used the words

of Warren Buffett, the chairman and CEO of Berkshire Hathaway,

another dual-class company, to promise shareholders, “We won’t

‘smooth’ quarterly or annual results: If earnings figures are lumpy when

they reach headquarters, they will be lumpy when they reach you.”

3

Page, Brin, and Buffett definitely understand the importance of quality

information to investors, especially in dual-class structures. But do dual-

class companies really provide investors with credible financial informa-

tion? This important question is at the heart of the discussion in this

article.

In recent years an increasing number of corporations have raised capi-

tal using a dual-class capital structure. The percentage of companies that

went public by listing dual-class shares on U.S. stock exchanges has

1

See Larry Page & Sergey Brin, 2004 Founders’ IPO Letter: “An Owner’s Manual” for Google’s

Shareholders,ALPHABET INV’R RELATIONS, https://abc.xyz/investor/founders-letters/2004/ipo-

letter.html [https://perma.cc/5YQK-LMHP] (last visited Mar. 29, 2020) [hereinafter 2004

Google Founders’ Letter].

2

Id.

3

Id.

444 Vol. 57 / American Business Law Journal

increased dramatically, from 1% in 2005 to 26% in the first half of 2019.

4

Google, Facebook, Snap, and Lyft are prominent examples of this trend.

5

This structure having become more common, its policy implications for cor-

porate governance and investor protection should be closely examined.

Dual-class capital structures create a gap between voting rights and

cash-flow rights.

6

Founders who want to raise capital without

relinquishing effective control of the company can issue different classes

of shares conferring unequal voting rights; that is, one class carries more

votes per share than the other. While the founders own stock with

enhanced voting rights (typically ten, or even more, votes per share),

public investors buy stock typically carrying one vote per share, or even

no votes at all. By issuing two or more classes of shares with unequal vot-

ing rights, founders can avoid the dilution that an initial public offering

(IPO) normally entails and hold on to most of the votes in shareholder

meetings, despite their relatively low equity investment. The founders

stay in control of the company even after it goes public.

Proponents of the dual-class structure argue that it encourages innova-

tion by insulating founders from market pressure.

7

Two main incentives

for going public with this capital structure have been pointed out.

8

First,

it enables the company’s founders to pursue their idiosyncratic vision for

4

See Dual-Class IPO Snapshot: 2017–2019 Statistics,COUNCIL OF INST’L INV’RS (2019), https://

www.cii.org/files/2019%20Dual%20Class%20Update%20for%20Website%20FINAL(2).pdf

[hereinafter Dual-Class IPO Snapshot]; Kristin Lin, The Big Number,WALL ST.J. (Aug.

17, 2015), https://www.wsj.com/articles/the-big-number-1439865699.

5

See Google Inc., Registration Statement (Amend. No. 9 to Form S-1/A) 29–30 (Aug.

18, 2004); Facebook, Inc., Registration Statement (Amend. No. 8 to Form S-1/A) 33–34

(May 16, 2012); Snap Inc., Registration Statement (Amend. No. 3 to Form S-1/A) 4 (Feb.

24, 2017); Lyft, Inc., Registration Statement (Amend. No. 2 to Form S-1/A) 55–56 (Mar.

27, 2019).

6

Stock pyramids and cross-ownership structures are alternative ways to create a gap

between voting rights and cash-flow rights. See Lucian Arye Bebchuk et al., Stock Pyramids,

Cross-Ownership,and Dual Class Equity: The Mechanisms and Agency Costs of Separating Control

from Cash-Flow Rights,in CONCENTRATED CORPORATE OWNERSHIP 295 (Randall K. Morck

ed., 2000).

7

See, e.g., 2004 Google Founders’ Letter, supra note 1 (“We are creating a corporate struc-

ture that is designed for stability over long time horizons. By investing in Google, you are

placing an unusual long term bet on the team, especially Sergey and me, and on our inno-

vative approach.”).

8

See infra Part I.B.

2020 / Dual-Class Firms 445