Monday, April 24, 2006

Unifying dual-class shares : Part 1

Recent days have seen a big move worldwide towards eliminating a dual-class share structure (Two classes of shares, for example Class A and Class B; where one class has substantially more voting power, or all the voting power, and the other class has very little or none).

Brazil's telecom company Telemar recently is looking to unify its share classes. (WSJ Subscription article). In the US, Eagle Materials recently decided to unify its two share classes.

New York hedge fund Atlantic Investment Management Inc. and Morgan Stanley are arguing that the New York Times Co. (NYT) should end its dual-class share structure.

Two questions.
The first: Why unify?

When a company's board and management are accountable only to a small group of people who hold very little of the actual fraction of shares outstanding, but all of the voting power, there is potential for decisions that are not in the common shareholder's interest.

Take the case of the aforementioned New York Times. Here's what Morgan Stanley Invmt. Management had to say about its reasons for supporting unification of NYT shares:

"MSIM contends that the Board and management at The New York Times Company have failed to fulfill (their) responsibilities effectively.While (dual class shares) may have at one time been designed to protect the editorial independence and the integrity of the news franchise, the dual-class voting structure now fosters a lack of accountability to all of the company's shareholders."

New York Times Co. stock has dropped 52% since its peak in June 2002, Morgan Stanley says. But "despite significant underperformance, management's total compensation is substantial and has increased considerably over this period. As a long-term, committed shareholder since 1996, MSIM has privately conveyed its concerns to the company's Board and senior management on a number of occasions and has suggested substantive strategies to operate the business better and allocate capital more efficiently. However, to date, the Board and management have failed to take the actions necessary to improve operational and financial performance."

Another article that explains why NYT is making the wrong decisions is here.

NYT is by no means alone in this quandary. Google Inc. has a dual class structure too, with its top three executives owning most of the voting shares, and the general public owning the Class B or non-voting shares. This decision cost Google in terms of its corporate governance ranking with ISS, the Institutional Shareholder Services.

So that answers the why. The second question is the 'how'?
Or more specifically, can the dual-class shareholder structure be changed?

Motley Fool argues that efforts to fight the dual-class share structure can be futile, once again, because the method of doing so usually involves a shareholder vote. In 1999, the big California pension fund CalPERS took on the dual-class structure at Tyson Foods (NYSE: TSN), arguing that the company had underperformed for years while under the dictatorial control of the founding family, and thus a recapitalization under a single-class structure was warranted. This push was rejected by Tyson's board (the putative advocates of shareholders) and defeated by the Tyson family's supervote.

And ISS also takes a dim view of the likelihood of being able to fight the dual class structure, if the owners of Class A shares were resistant to the idea of unification.
It should come as no surprise that ISS is against the establishment of dual-class equity structures in all cases as it is the single most disenfranchising thing a company can do to investors... We almost always support shareholder proposals seeking to eliminate dual-class structures. The actual elimination, of course, never happens because the people who benefit most from dual class structures control the voting power at the company. However, because these structures have a long legacy, we generally do not proactively withhold votes from directors at companies with dual-class structures in place unless there are other significant governance issues.

- from the ISS corporate governance blog,this post.

Next up in part 2: results of studies on the costs and drawbacks of having a dual-class structure.

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