Both sides now – pros and cons of dual shares

Both sides now – pros and cons of dual shares

Business Times

20 Jan 2014

Adrian Chan

BOTH the Hong Kong and Singapore stock exchanges currently have a “one share, one vote” system. To control a company, one needs to own a significant number of shares.Alibaba, China’s leading Internet group with a potential market value of US$60 billion, wanted to bend this rule in Hong Kong when it explored an IPO (initial public offering). It demanded that its management team – mainly founders and senior executives – have an ongoing right to nominate a majority of board members, even though they only have 13 per cent ownership of the company.

Talks between the company and the Hong Kong Stock Exchange collapsed in September 2013; but now, it appears that both sides are backing down. The exchange is said to be considering a reform of its listing rules, while Alibaba is said to be willing to renegotiate a listing in Hong Kong.

Different stock exchanges have different rules when it comes to dual-class shares – shares that have different control or voting rights.

The United Kingdom discourages them to the point of extinction, though they were in vogue in the 1960s. In continental Europe, they are allowed.

In the United States, the structure has become de rigueur for the hottest tech IPOs, from Facebook and LinkedIn, to Zynga and Groupon.

In Singapore, the Companies Act is in the process of being amended to allow public companies to issue non-voting and multiple-vote shares. The Ministry of Finance said that this will give companies “greater flexibility in raising capital, and meet different investor preferences”.

When this change becomes effective in the second half of 2014, the ball will be in Singapore Exchange’s (SGX) court to decide whether or not listed companies should be allowed to issue shares with different voting rights.

The two sides of dual shares

There are good reasons for disallowing dual-class shares.

The one-share one-vote system lets all shareholders exercise their collective wisdom to elect the board of directors who, in turn, appoint management to run the company in the interests of shareholders. The board of directors is thus fully accountable to all the shareholders.

Giving free rein to the management team to appoint the majority of the board of directors is viewed by many as upsetting the cart of good corporate governance. After all, a board appointed by management is likely to be friendly to it, and lacking in independence.

Can such a board truly discharge its duty to ensure that management makes compensation, investment and financing decisions that are in the best interests of all shareholders?

On the flip side, there is just as strong a case to be made for allowing management time and resources to execute its vision.

As to equity, the argument is that as long as management’s influence on the choice of directors is fully disclosed and known, this fact will be reflected in the share price of the company.

Which type of share structure is better for shareholders? The US experience is mixed:

Some dual-class stock companies have performed exceptionally well, eg Google, Nike, Comcast, Berkshire Hathaway.

Some dual-class stock companies perform at average levels, but raise the ire of investors who agitate for change, eg News Corp, The New York Times, Ford Motor Company.

Some dual-class stock companies are led by executives who have allegedly abused their power, eg Hollinger International.

More than a few single-class stock companies have destroyed shareholder value, eg Worldcom, Enron, Tyco, Healthsouth.

A pragmatic approach

In corporate governance, sometimes one size does not fit all.

Dual-class structures clearly have benefits and drawbacks.

One approach might be to allow dual-class structures, but at the same time have checks and balances to mitigate the risks.

Such checks and balances could include:

Requiring full and ongoing disclosure of the relationships between members of the management team and directors.

Giving the public shares some rights to approve or veto certain major corporate actions, such as changes to the core business, constitution of the company, liquidation, etc.

Giving management shareholders a qualified right to appoint the board. This right, for example, can be nullified if there are early warning signs or red flags pointing to impending insolvency, potential defaults, qualifications to the accounts, and material conflicts of interest.

Limiting the management shares to only founder-managers.

Requiring the nominating committee to be made up entirely of independent directors. This is a tightening of the current position in the Code of Corporate Governance which only requires the nominating committee to be made up of a majority of independent directors.

These suggestions are not too difficult to provide in the SGX’s Listing Manual, or even in a company’s constitution.

Such an approach could allow an exchange to be competitive and attractive to successful companies with founder-managers, while maintaining the confidence of other shareholders that their interests are protected.

The writer is the first vice-chairman of the Singapore Institute of Directors.