Can Democracy Stage a Comeback at Stock Exchanges?

Scan stock markets around the world, and you’d be forgiven for thinking democracy was under attack. The principle of one share, one vote has been around since companies started selling shares to the public in the early 17th century. Today its recurring nemesis—dual-class shares, which grant different classes of owners different voting rights—is back, big time. And exchanges that have shunned dual-class share listings are wrestling with an age-old dilemma: Should we or shouldn’t we?

For exchanges, the appeal of such listings is plain enough. Competitive pressures among stock markets are intense. Plus, there are some big technology listings on the horizon, including Dropbox and Mobvoi, an Alphabet-backed Chinese artificial intelligence startup. So Hong Kong, London, and Singapore are weighing whether, like some of their competitors in New York and elsewhere, they should list dual-class shares. “There is an air of inevitability around it,” says David Smith, Asia head of corporate governance at Aberdeen Standard Investments. “We are mindful of the risk of contagion. Once one regime allows it, others will surely follow.”

The lessons for exchanges that have steered clear of dual-class share listings are equally obvious. Take Hong Kong. Over the past decade, Hong Kong Exchanges & Clearing Ltd., a natural listing venue for Mainland Chinese companies, lost out to the U.S. on $34 billion in initial public offerings featuring weighted voting rights, including Alibaba Group Holding Ltd., the world’s largest IPO. “A big concern for HKEX is that there will be more really significant companies like Alibaba, and Hong Kong will lose them if it doesn’t do something to accommodate the special governance arrangements they have,” says Robert Cleaver, a corporate lawyer in Hong Kong for global law firm Linklaters. “There is a strong feeling in the market that they have got to do something.”

Dual-class structures have long been seen as the niche province of newspaper barons (the Sulzbergers at the New York Times, for example) and automakers (the Fords, say, at Ford Motor Co.), and drugmakers (Roche Holding AG). They allow founding families to retain control and raise funds at the same time, wielding outsize powers at the expense of ordinary shareholders. Because of that, they’ve been stirring controversy for decades.

In 1925, Dodge Brothers Motor Car Co. caused a ruckus on the New York Stock Exchange when the family owned 1.7 percent of the company but had total voting control. The imbalance eventually led to a 1940 NYSE rule outlawing new dual-class stock issues. Then, in the 1980s era of corporate raiders, the tables turned as dual-class structures were increasingly used as armor against takeovers. In the end, after some companies threatened to list on the upstart Nasdaq Inc., the Big Board relented and let dual-class listings back in.

Today’s founders of technology startups have followed in the footsteps of industrial and manufacturing magnates of old, embracing a governance model that allows them to tap capital markets yet retain control. In 2004, only six years after it started doing business, Google Inc. went public with an eye-popping $23 billion valuation, a price-earnings ratio of 80—and, through its dual-class share structure, a huge bet on its creators, Larry Page and Sergey Brin.

Other tech companies soon followed: Facebook, Groupon, and, from China, JD.com, Baidu, and Alibaba, which gave special voting rights to management partners. One percent of U.S. IPOs had weighted voting rights in 2005, according to Sutter Securities Inc. in San Francisco; a decade later 15 percent did, with technology companies making up more than half the total.

Given the storied but checkered history of dual-class shares, it’s perhaps inevitable that the weight of opposition would shift against them once more. It peaked in March when Snap Inc. went public, offering new shareholders zero voting rights. For many, this was a listing too far. (As of Sept. 15, Snap shares had fallen 10 percent.) “The issue has really been brought to the fore by Snap,” says Mark Makepeace, chief executive officer of FTSE Russell, an index provider owned by the London Stock Exchange Group

 
 
The worldwide enthusiasm for dual-class shares isn’t just about money. Nabbing big listings brings prestige and increased trading volumes as well as fees to the winning exchange. “You can argue that in this economy it could be the vision, could be the product, could be the patent, could be a lot of things that are intangible,” says Charles Li, head of Hong Kong’s stock exchange operator. “In this new world, we need to look at that, give credit to that particular power.”

Dual-class shares may be about to make a comeback in Hong Kong. They first appeared in the former colony in the 1970s, only to be scrapped more than a decade later amid a wave of public-interest concern. HKEX currently offers two platforms: the main one, for established profitable com­panies, and a second, its Growth Enterprise Market. It recently consulted the market about introducing a third board, where dual-class listings would be permitted.

Hong Kong’s push comes amid a shrinking global IPO market. In 2006 more than 2,100 companies raised $293 billion through initial share sales, according to data compiled by Bloomberg. Last year that number tumbled to $144 billion. HKEX’s move could have a domino effect in other regions. Bankers, traders, and the exchanges themselves are all “very power­ful forces” in favor of generating new business, says Jamie Allen, secretary general of the Asian Corporate Governance Association in Hong Kong. “Other exchanges have told us that if Hong Kong goes ahead,” he says, “they will have to consider it.”

Singapore Exchange Ltd., Southeast Asia’s largest stock market, is poised to join the movement. The Singapore government has backed a dual-class share plan as part of a package to drive economic growth over the next 10 years. Aware of how controversial this issue is, SGX has taken the unusual step of having a two-stage consultation aimed at winning over the market. And in London, the Financial Conduct Authority raised the possibility of relaxing its listing restrictions in a February discussion paper on the effectiveness of its markets.
 
 
For a while, says Jay Ritter, a finance professor at the University of Florida, it looked as if dual-class opponents were losing the debate as more companies chose the model and exchanges increasingly considered allowing such listings. Exchanges that missed out, as HKEX did in the case of Alibaba’s mega-IPO, must be kicking themselves, says Kai Li, a professor at the University of British Columbia’s Sauder School of Business. After all, she says, “dual-class firms are a new breed and are creating shareholder value.”

But Maurice Teo, a representative of the CFA Society Singapore, says dual-class shares, with their differently weighted voting rights, are inherently not in investors’ interests. He says exchanges, in their eagerness to gain a competitive edge, might be overlooking this.

What’s more, says Aberdeen’s Smith, a dual-class structure is hardly a prerequisite to corporate prosperity. He says there are many successful tech companies with single-class share structures. Facebook Inc. shares have soared more than 300 percent since their May 2012 debut through the end of August. In the same period, the S&P 500 rose 89 percent, Microsoft Corp. 152 percent, and Amazon.com Inc. 349 percent.

Pressure against weighted voting rights has mounted. In September, just days before a shareholder challenge was coming to trial, Facebook called off plans for a new share class that would have further cemented co-founder Mark Zuckerberg’s control. Partly goaded by investors who associate dual-class shares with weak corporate governance, MSCI Inc., FTSE Russell, and S&P Dow Jones Indices have joined the opposition.

MSCI Chairman and CEO Henry Fernandez calls the rise of dual-class shares a “problem in the world.” In July, FTSE Russell threatened to boot more than 30 com­panies, including Hyatt Hotels Corp. and IT provider VMware Inc., off its indexes unless ordinary share­holders have at least 5 percent of voting rights. Days later, S&P put a block on such shares in future listings on its U.S. indexes.

The stands taken by the index titans were a symbolic win for opponents of dual-class shares. “Companies like to be included in indexes since it usually results in a higher share price,” Ritter says. He says the moves by the index firms will discourage companies from adopting the structure.

Big asset managers—including Norges Bank Investment Management, the world’s biggest sovereign wealth fund, and BlackRock Inc.—have also joined the chorus of dissent. But to what end? The Norwegian fund is among the largest investors in Facebook and Alphabet Inc.; BlackRock owns Snap shares. Pru Bennett, BlackRock’s Hong Kong-based head of investment stewardship for the Asia Pacific region, says the money manager supports one share, one vote and opposes exchanges’ plans to list dual-class shares. When BlackRock invests in companies with weighted voting rights , she says, the structure’s risk is taken into account.

Investors don’t always have a choice. The rise of index-linked passive investing means trillions of dollars are funneled into dual-class stocks automatically, regardless of corporate governance concerns. So who, then, is going to stem the tide? Only the fund management industry is in a position to do that, says George Cooper, chief investment officer at Equitile Investments Ltd. in London. “We are hiding behind the index process,” he says. “The industry is abdicating responsibility. The buck stops with us.”
 
 Tan and Robertson cover market structure for Bloomberg News from Singapore and Hong Kong, respectively. With David Ramli and Lulu Chen.