Document Type

Article

Publication Date

12-17-2018

Abstract

An increasing percentage of corporations are going public with dual class stock in which the shares owned by the founders or other corporate insiders have greater voting rights than the shares sold to public investors. Some commentators have criticized the dual class structure as unfair to public investors by reducing the accountability of insiders; others have defended the value of dual class in encouraging innovation by providing founders with insulation from market pressure that enables them to pursue their idiosyncratic vision.

The debate over whether dual class structures increase or decrease corporate value is, to date, unresolved. Empirical studies have failed to provide conclusive evidence as to the effect of dual class structures, and calls for regulators or stock exchanges adopt prohibitions banning dual class structures outright have been unsuccessful, although several index providers have banned dual class stock from major indexes such as the S&P 500.

As a result, some commentators have advocated a compromise position permitting corporations to go public with dual class structures but requiring that they be required to include mandatory time-based sunset provisions. The sunset provisions would automatically convert the dual class structure to a single share structure after the passage of a pre-determined period of time. The Council of Institutional Investors has asked the New York Stock Exchange and Nasdaq to refuse to list the shares of dual class firms unless they contain a time-based sunset provision that would convert within seven years.

We do not take a position on whether dual class structures are value-enhancing, but we challenge the proposition that time-based sunsets are an appropriate response to the debate over dual class and that they should be imposed through regulation or stock exchange rules. To the extent that dual class structures are problematic, sunsets do not solve that problem. Moreover, time-based sunsets are an arbitrary response to the concern that developments such as the decline in a founder’s economic interest or the transfer of high-vote shares to third parties may reduce the attractiveness of the dual class structure. In addition, time-based sunsets create potential moral hazard problems. We further argue that the limitations of time-based sunsets cannot be addressed through a retention vote by the minority shareholders due to the problematic incentives of the minority shareholders.

We observe that event-based sunsets, which have received less attention, focus on the specific developments that are likely to erode the potential value of dual class, and we call for market participants to explore them further through private ordering. Nonetheless, we argue that, at the present time, investors and policymakers lack sufficient information about either dual class or sunsets to justify using regulation, index requirements or stock exchange rules to force companies into adopting sunsets. We further argue that, rather than relying compulsory sunsets to evade the difficult policy issues raised by dual class, the debate should encompass a more thorough framing of the role and importance of shareholder voting rights.

Publication Citation

Boston University Law Review (forthcoming 2019).

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