Last March, Under Armour (UA) issued a new, Class C, shares to all existing shareholders. All the company’s share has the same economic interest in the company, but Class C shares have no voting rights. UA has two other share classes: A shares with one vote, and B shares, owned by the company’s founder, having 10 votes each. “As of Friday [November 25], C shares were trading at a 22% discount to A shares—a spread that has widened from 3.7% on March 23, the first day the C shares traded.” (The Wall Street Journal, November 28, 2016.) UA, reports the Journal, is worried about the deep discount of its C shares because it plans to use the shares for executive and employee compensation. A certain discount for non-voting shares is reasonable because they have no control rights (“control premium”), but in UA’s case the voting A shares don’t have much control either because founder and CEO Kevin Plank holds all the B shares, giving him 65.3% of the vote—virtual control. Despite the deep discount, reports the Journal, the C shares still trade at the healthy multiple of 35 times 2017 earnings. So, perhaps the A shares are overpriced? The multiclass share Under Armour and it’s ilk raise important questions for investors:
How prevalent are multiclass shares? What’s their justification? And most importantly, should investors acquire no, or reduced-voting shares? Let’s examine these questions.
There are about 130 multiclass share companies in the S&P 1500 universe. A minority, to be sure, but not an insignificant minority. Multi (mainly dual) class stocks were first used by media companies (New York Times) to protect the journalistic integrity of the news from politically-motivated shareholders. The practice spread, and in recent years is used primarily by high tech and Internet companies. Google, Facebook, LinkedIn, Groupon, Yelp, and Zynga have multiclass shares. The practice is even more popular abroad, where family-owned companies going public maintain the owner-founder’s control with special voting rights shares.
The NYSE banned multiclass shares between 1926 to 1985, arguing that only one-share-one-vote was fair to investors. After 1985, bowing to competitive pressure from NASDAQ and AMEX which allowed multiclass shares, the NYSE now also allows multiclass shares, as long as this structure was in place at the time of IPO. Proponents of multiclass shares claim that they shield owners-managers (Mark Zuckerberg at Facebook, or the Google founders) from pressure by short-term investors to sacrifice company growth (cut R&D, technology investment) for beating quarterly earnings targets. Critics counter that the real reason for multiclass shares is to thwart activist investors and hostile takeovers (you’ll have to acquire the main owners-founders’ shares to control the company) thereby entrenching those with control over the company. So, we have here the classic long-term value pursuit vs. management entrenchment arguments, similar to those raised about staggered boards or takeover defenses. If the entrenchment critics are right, then the performance (profitability, share performance) of multiclass companies, where lax and incapable managers prosper, should lag behind those of a single share class companies.
The empirical record, unfortunately, is somewhat mixed: Two academic studies failed to find a significant performance difference between multi– and single-class share companies, whereas a 2012 study by the Institutional shareholder services (ISS) reports that single-class voting companies outperformed multiclass shares companies over 3-10 years, while over one-year period, multiclass companies outperformed one-share-one-vote companies. Multiclass companies also exhibited more share price volatility and more related party transactions than single class companies.
Summarizing, the somewhat scant research doesn’t seem to support the pro-multiclass claim that multiclass share companies enable their managers to focus on the long-term and generate superior performance. They are either equal to, or underperforming single-class companies. So, unless you believe that the multiclass investment opportunity is unique, with a significant upside (Google, Facebook), why invest in such companies?