Dual-Class Shares: The Fear of Missing Out?
The fear of missing out (FOMO) typically refers to the uneasiness that one is not “in-the-know” or is “out of touch” with some social events, experiences, and interactions. Recently, FOMO appears increasingly prevalent in the financial industry too, particularly in markets in Asia that are actively considering allowing companies with dual-class shares (DCS), or differentiated voting rights, to list. Proponents of such structures crow about the benefits these IPOs would bring: attracting listings of high-growth technology companies, allowing investors to participate in such growth, and bringing businesses to intermediaries and stock exchanges¾what is not to like about DCS? No one wants to miss out on the next Alibaba, Google or Facebook, right?
Through conferring super voting rights to certain share classes, DCS structures allow founders and insiders to retain control of their companies, despite successive rounds of dilutive equity fund raisings, thus creating a gap between equity ownership and control. This gap (often referred to as the wedge) can be problematic: controlling shareholders are protected from the disciplinary forces of the market, leading to reduced levels of accountability and entrenchment risks. Since their equity holding is low, even if they make bad decisions and mismanage the company, their “pain” is limited. Thus, DCS structures are typically associated with lower corporate governance standards and an erosion of shareholder rights.
Authorities in India have spent a great deal of time and effort in improving corporate governance, and much progress has been made in the area. Further, Securities and Exchange Board of India (SEBI) is reportedly looking to publish a stewardship code for institutional investors, creating a framework for them to engage with investee companies, thereby raising corporate governance standards. Allowing DCS structures to proliferate may send the wrong signals to the market regarding India’s determination in sustaining this momentum, just as this work reaches a critical juncture with the implementation of the Kotak recommendations. Investors will justifiably question if their rights will be upheld and if India is indeed a desirable destination for deploying their long-term capital.
In the recently published 2018 OECD Equity Market Review for Asia, for the 10 years ending in 2017, the top five jurisdictions by number of nonfinancial company IPOs were China, the US, Australia, India, and Korea. Of this list, DCS structures are most common in the US, but neither China, Australia, nor Korea allows it, and yet that hasn’t stopped these markets from being large and significant IPO markets over the last decade. Granted, public capital formation is taking place at a much higher rate in developing markets, but even for a developed market such as Australia, their adherence to one-share, one-vote has not diminished its attractions as a listing venue. As a matter of fact, Australia has won a number of cross-border technology IPOs in the last few years (including ones from Singapore, New Zealand, the US and Israel)¾ issuers like it for its deep pensions pool and sophisticated investor and analyst community, as well as its clear, transparent regulatory framework. This highlights an argument we have been making all along: there are many factors contributing to the selection of a listing venue, and DCS is not the silver bullet that will provide a sustainable competitive advantage.
Against this backdrop, why are markets still actively considering DCS? Perhaps it is a reaction to FOMO. As the equity bull market draws to end and the liquidity cycle turns, it will be interesting to see if the FOMO fever abates.
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