Every area has its debate that won't go away: Is Peyton Manning a better quarterback than Tom Brady? Is string theory a viable theory of everything? Did Han Solo shoot first? In corporate law, it's the debate over what constitutes good corporate governance that, recently, has been revived by the debate over a long-slumbering aspect of corporate law: dual-class share structures.
Companies with dual-class share structures generally have one class of shares that give multiple votes to one group of shareholders, usually company founders and management, while leaving shareholders who buy shares traded on a public market one vote per share. The upshot is that these multiple-voting shares allow founders and management to retain control over a company after its initial public offering (IPO), which has proven to be a controversial proposition.
While clearly allowed under our securities laws, the debate over the policy wisdom of dual-class shares has been rekindled by a number of high-profile public offerings that have featured these structures. The most high-profile of these was Facebook, where the multiple-voting shares allowed Mark Zuckerberg to retain control over the company and your news-feed.
Closer to home, the IPO of Cara Operations Ltd. (the parent company of Swiss Chalet) and Spin Master Corp. (full disclosure, I worked on this transaction) have used multiple-voting shares to keep control in the hands of company founders. Recently, these structures have entered the world of politics as Canada's Liberal government has raised concerns about Bombardier's dual-class share structure, with sources saying changes to the ownership structure would be a condition of financial assistance from Ottawa.
As I discussed a couple of weeks ago, companies are increasingly turning to private market financing to access capital while avoiding the regulatory restrictions of public markets. However, at some point, investors want an exit from their position, and public markets offer access to far greater amounts of capital than private markets. Multiple-voting shares let founders and investors achieve both ends without sacrificing control.
Many see this as a problem. Single-vote shareholders lack sufficient votes to remove a board they feel is no longer acting appropriately. Meanwhile, courts and regulators give boards deference in the exercise of their fiduciary duties, making legal challenges difficult. So, the argument goes, dual-class shares can lead to board entrenchment.
Of course, an equally vocal group sees multiple-voting shares as a way for founders to focus on the long-term growth of a company. Would Facebook really be a more secure, more highly valued company if Mark Zuckerberg had to spend more time focusing on quarterly earnings and less time on helping Facebook to grow over the long run?
While the debate over corporate governance is fun, it side-steps the economics of dual-class shares and how such structures enforce the policy goals of our corporate and securities laws. Dual-class structures are an important part of negotiated transactions and function well within securities markets.
The corporation is a legal fiction. It's an entity that exists to allow individuals to organize their business affairs in a flexible, liability-limiting entity. As such, our corporate statutes contain a set of generally efficient and sensible default rules that shareholders can agree to modify in order to better suit their ends. On top of these rules lie fiduciary duties and the oppression remedy, which ensure that directors act in the best interests of the company.
When a company transitions from private to public, the private shareholders enter into negotiations with investment bankers who are charged with pricing the shares and bringing them to market. During this process, founders want a high price for the company's shares, while bankers want shares with a price they can market.
So, if dual-class structures are unappealing to investors, they will cause the company to launch its IPO at a lower price. This creates a strong economic incentive to avoid dual-class structures.
So why do dual-class structures persist? One compelling reason is that founders value running a company more than they value more money during an IPO. So, if a dual-class structure is only marketable at a discount, that discount must be less than what the founders value control at. In that sense, dual-class structures are economically efficient and in the spirit of corporate law: Founders and underwriters, on behalf of investors, have bargained to an agreement appealing to all involved.
Similarly, if Bombardier capitulates to Ottawa, this too will be a function of negotiation – Bombardier will have revealed itself to value government assistance over family control. If it values family control more than government assistance, it will reject the offer.
Since companies and investors can bargain over a board's right to maintain its position, we have good reason to believe that the results of these bargains will benefit both parties.
Outside of the political arena, where market prices are less important than more political concerns, if markets and securities law disclosure requirements are operating properly, then any subsequent risk of board entrenchment should be priced into the shares once they hit the open market. Indeed, empirical evidence shows that dual-class offerings are priced at a discount but their shares perform about the same as the shares of other companies in open trading.
Where there are legitimate concerns with multiple-voting shares, our laws are well equipped to deal with them. During hostile takeover situations, dual-class structures can lead to legitimate conflicts of interest between board members as shareholders and board members as fiduciaries. As UCLA legal professor Stephen Bainbridge suggests, these issues can be solved with conflict-of-interest rules, not by imposing constraints on company share structures. Or, fears of minority shareholders receiving a discount during acquisitions can be solved with provisions guaranteeing equal consideration, such as the "coattail" provisions on the Toronto Stock Exchange.
There's a strong value in negotiated contracts, an enabling corporate law with strong fiduciary duties, and a securities law that's focused on improving asset pricing. True democracy in the corporate sphere is the daily referendum that takes place on the TSX. If Facebook wants multiple voting shares, let Facebook have multiple voting shares. I doubt a mandated share structure is better for the company than the one Mark Zuckerberg negotiated with his underwriters prior to the IPO. And if he was wrong, we can trust the markets to hit the dislike button.
Adrian Myers is a lawyer at Torkin Manes LLP.