What is the purpose of dual class shares?2 min read . Updated: 11 Dec 2018, 03:05 PM IST
Dual class shares help the promoter retain management control and give limited voice to other shareholders
Did you know that Facebook’s CEO and founder Mark Zuckerberg has close to 54% voting rights in the company where he holds roughly 28% of class B shares. Why are his voting rights so much higher? What are class B shares?
Some companies have two types of share classes, one with enhanced voting rights and the other with limited voting rights; these are known as dual class shares. In case of Facebook, the class B shares have 10 votes per share. Dual class shares help the promoter retain management control and give limited voice to other shareholders.
Certain companies, specifically in the IT industry, find this a useful way to grow. Start- ups exploring new technology often don’t have a proven market. Thanks to the inherent dynamic nature of the business, there is constant need for raising capital to fund growth. At the same time, the expertise required is specialised and, in many cases, restricted to founders. This combination results in the idea of raising equity funds without diluting control and, hence, the need for dual class shares.
The concept has worked best in the US market and has been recently introduced in Asian equity markets through Singapore- and Hong Kong- based stock exchanges.
Pros and cons
While it works well for the founder management, as the company grows in size and public shareholding expands, the skew in control via voting rights starts to feel unfair. According to a study by CFA Institute on dual class shares, there is no assurance that the outperformance of a company continues indefinitely. When things go wrong, public shareholders have little influence as without a vote they cannot provide oversight to boards and management.
This can also dilute issues of governance where there is scope for misuse of control.
It is not a very popular way of managing control in companies. However, some experts argue that to expand business growth in new-age sectors, this route of raising funds can work more effectively.
The CFA Institute study recommends that in markets where retail participation is significant, but legal recourse against rogue companies not viable, exchanges and regulators need to create awareness for outcomes of dual class shares. Also, regulators must intervene in a timely manner when investors are taken advantage of or harmed, said the study.
The Indian context
For Indian companies, there is a provision of creating differential shares for diluting stake. These are called differential voting right shares or DVRs; similar to dual class shares, voting rights on DVRs are different from those of the regular shares issued by the company. Only a handful of listed companies in India have so far gone this way. DVRs are also unpopular because they trade at a relative discount to the full voting right share class. In India, many companies are closely held by promoters and public shareholders are often a minority to begin with.