It is a truism that the one who has the gold makes the rules. But when it comes to many businesses, the one who has the super-voting shares makes the rules. Some companies issue two types of common stock, including special common shares, each of which gives the holder the right to 10 votes, and ordinary common shares that each get a single vote.
Several hundred public companies have dual-class shares, typically split between super-voting Class A shares and ordinary Class B shares. Among the most notable examples are Viacom, Google, Facebook and Berkshire-Hathaway.
Super-voting shares are typically used to let founders and their families to maintain control of companies even when they own less than majority shares of the common stock. Ford, for instance, went public in 1956 and today the family owns just 4 percent of the equity. However, super-voting shares give it 40 percent of the votes so the family effectively controls decisions made by the board.
Founders and founder families like super-voting shares because they protect them against loss of control. It can be beneficial, because a firm controlled by the family can be less attentive to the short-term objectives of Wall Street. Also, when the founder is recognizably a superior manager, as case with Warren Buffett of Berkshire-Hathaway, keeping the founder in charge can comfort other investors. Also, super-voting shares normally can’t be traded like regular shares, encouraging long-term ownership stability.
But dual-class shares also have a downside. A study by scholars at Harvard Business School and the Wharton Business School found that as insider’s voting power grows, company performance falters. Specifically, as voting power increases from zero to 45 percent, one broad performance measure declined by 25 percent.
Interestingly, the opposite effect was found when insiders’ share of ownership increased without any super-voting shares. Using the same performance measure, the positive effect came to 15 percent better performance as insider ownership rose to 33 percent, when the beneficial effects peaked. This occurred, the researchers suggested, because managers made better decisions when they had more skin in the game.
The researchers explained the negative effect of super-voting shares as resulting in part from families’ unwillingness to dilute their holdings and control by issuing more ordinary shares. That reluctance forced the company to borrow more rather than tapping the relatively inexpensive equity markets for capital, increasing leverage and interest costs. Investors tended to be skeptical of the family’s insistence on retaining control, which depressed the stock price, the researchers said.
Of course, there are exceptions, starting with Buffett and Berkshire-Hathaway. Also, investors don’t seem spooked by the dual-class equity structures of Google or Facebook, which are among the most highly valued and profitable companies in the world. But those are the exceptions. Most families in most businesses should probably realize that, while super-voting shares allow them to retain control, this may come at a cost to the business’ performance.
Having two classes of common stock can give founders superhuman clout when affecting actions by the company’s board of directors. But they are often not without effects, some of them negative, on investors, balance sheets and the company’s long-term value. Generally, it seems to be best if the one who has the gold — as represented by a majority of the equity — makes the rules, rather than the one who has the super-voting shares.