New Study Says Multiclass Voting Companies Underperform, Riskier
Number of Controlled Companies on the Rise
NEW YORK, NY, October 2, 2012 - A new study finds that controlled companies – particularly those with multiple classes of shares – generally underperform over the long term. As compared to companies with dispersed ownership, controlled companies experience more stock price volatility, increased material weakness in accounting controls, more related party transactions, and offer fewer rights to unaffiliated shareholders. The study results challenge the notion that multiclass voting structures benefit a company and its shareowners over the long term.
The study, Controlled Companies in the Standard and Poor’s 1500: A Ten Year Performance and Risk Review, was commissioned and funded by the Investor Responsibility Research Center Institute (IRRCI) and conducted by Institutional Shareholder Services Inc. (ISS). The full study is available here.
Most U.S. companies feature "one share, one vote" governance provisions to allow voting power to elect directors that is directly proportional to an investor’s capital at risk. For a growing number of companies, however, voting power is concentrated through the use of different share classes to allow insiders or founders to control board of director elections.
The study discusses a recent quartet of high-profile technology companies that went public with such multiclass governance structures. Of these four, only Linked In has rewarded investors as of August 31, 2012, with a 138% stock price increase since its initial public offering (IPO). The stock prices of Zynga, Groupon, and Facebook, however, are far below their initial public offering (IPO) prices by 72.0, 79.3 and 52.5 percent, respectively. The study makes clear that this issue of multiclass ownership structures extends far beyond these recent technology sector companies.
Key findings of the study include:
- The number of controlled companies has increased over the last decade. In 2002, there were 87 controlled firms in the S&P 1500 Composite; today, there are 114. Of these, 79 feature multiclass capital structures with unequal voting rights and 35 are controlled firms with a single class of voting stock.
- Contrary to the theory, non-controlled firms outperformed controlled firms over the 3-year, 5-year and 10-year periods ended August 31, 2012. Control companies featuring multishare classes only outperformed over the shortest time period measured – one year – and materially underperformed over longer periods of time. By contrast, control companies with a single share class outperformed all others over longer time periods. The nature of the control mechanism appears to matter.
- Controlled companies with multiclass structures consistently exhibit materially more share price volatility than non-controlled companies. By contract, controlled companies with a single class of shareholders consistently exhibit more share price stability.
- Controlled companies have more material weaknesses in control environments than non-controlled companies.
- Controlled companies have more related party transactions than non-controlled companies.
- Institutional investors cite concerns with investing in controlled companies, but generally do not have formal policies concerning such firms. Most investors report that controlled firms are less responsive to their inquiries and engage in less outreach than non-controlled firms.
- The governance provisions of controlled firms with a single class of stock often differ from those with multiclass capital structures, and in some respects more closely resemble those of non-controlled firms. Controlled firms with a single class of stock have more conventional governance features with respect to board accountability and shareholder rights compared to controlled firms with multiclass capital structures.
"Investors have long taken a limited view toward controlled firms with multiclass capital structures because of such structures' inherent negative impact on the rights of unaffiliated shareholders," said Sean Quinn, report author and vice president with ISS. "This study finds that in addition to offering unaffiliated shareholders comparatively fewer rights, these firms underperform and show higher levels of risk than their single-class peers," he said.
"Recent IPOs have thrust the issue of multiclass companies into the spotlight," said Jon Lukomnik, IRRCi executive director. "Supporters of these structures claim that control of a company's voting power enables management to govern with minimal outside interference and focus on long-term business growth, and ultimately deliver higher returns to shareholders in exchange for control rights."
"However, the study finds the opposite to be true. When control is exercised through multiclass structures, those companies perform worse and are more risky. In contrast, when company control is aligned with unaffiliated investors in a single class of stock, the result is companies perform better over the long haul and are less risky. Alignment matters. The method of control matters."
In this study, the definition of control included any person or group owning 30 percent or more of a company's voting power. The study examines firms in the S&P 1500 Composite Index as of Jan. 1, 2012, and discussions with representatives of six institutional investors and two investment banks to provide context to observable findings.
The Investor Responsibility Research Center Institute is a not-for-profit organization headquartered in New York, NY, that provides thought leadership at the intersection of corporate responsibility and the informational needs of investors. More information is available a www.irrcinstitute.org
Institutional Shareholder Services Inc. is the leading provider of corporate governance solutions to the global financial community. More than 1,700 clients rely on ISS' expertise to help them make more informed investment decisions on behalf of the owners of companies. More information is available at www.issgovernance.com.