An Argument against Dual-Class Shares

Many companies offer a dual class of shares of stocks, which means there are two ways to participate in company ownership. Typically, one of the share classes grants more control over the company, and for this and other reasons, many investors find the disadvantages of such arrangements outweigh the benefits. Following is a definition of dual-class share companies and several points investors use to argue against them.

What Are Dual-Class Stocks?

In a publicly owned company, ownership is vested in shares of stock that can be purchased by individual investors. Typically, a share of stock grants one vote to the owner so that the more heavily an investor is invested in a firm, the more control he or she can exercise.

In a dual-class stock company, there typically are two kinds of shares. Often, these are labeled as "A shares" and "B shares." (They should not be confused with stocks labeled "preferred" and "common shares," which are different from the dual class shares.)

Dual-class stock arrangements are common for family-owned companies in which the family wishes to participate in the equity market--by selling shares and raising money for expansion--and also retain control. In such an instance, the owning family would issue a limited number of voting shares to itself and sell a much larger number of non-voting shares.

The Problem of Control

Many investors begin the argument against dual-class shares with the issue of control of the company. While there may be thousands of investors with millions or even billions of dollars invested, the firm can be controlled by a relatively small group of people. In a single class stock company, if management acts contrary to the wishes of the stockholders, the company leaders can be voted out and new leadership installed. Dual-class stock companies often do not offer this alternative to investors in the non-voting stock.

Issues of Performance

The second argument against dual-class stock companies concerns how well the stock performs. Investors expect the value of their stock to rise or the company to issue a dividend to shareholders from profits or both. Yet some studies have shown that dual-class stock companies underperform single-class stock companies. Combined with the limited ability to remove management, this aspect of dual-class stocks causes some investors to avoid them.

The Challenge of Family Ownership

Not all dual-class stock companies are family owned, but many are. As companies grow and outlast the founding generation, familial infighting can harm a company’s reputation and performance. Yet, in such a company, there is little shareholders can do to force changes on the family. If family members sitting on the board have differing views on how the company should move forward, that can cause the company to miss opportunities or stagnate.

The Challenge of Family Ownership Changes

Even with a dual-class stock company, the ownership of the company can change hands without the permission of the B-share stockholders if the family elects to sell. This is the opposite of the problem outlined above when shareholders can’t change underperforming management, yet it remains a significant risk for Class B investors in family-held dual-class stock companies.

blog comments powered by Disqus