The Investor Stewardship Group (ISG), a collective of U.S. and Canadian asset management firms managing over US$17 trillion and including BlackRock, Inc. (NYSE:BLK), the world’s biggest asset manager, is calling for an end to dual-class share structures.
The following is taken verbatim from the ISG’s website:
Principle 2: Shareholders should be entitled to voting rights in proportion to their economic interest.
2.1 Companies should adopt a one-share, one-vote standard and avoid adopting share structures that create unequal voting rights among their shareholders.
2.2 Boards of companies that already have dual or multiple class share structures are expected to review these structures on a regular basis or as company circumstances change, and establish mechanisms to end or phase out controlling structures at the appropriate time, while minimizing costs to shareholders.
That immediately calls into question two of the most recent IPOs on the TSX: Aritzia Inc. and Freshii Inc., whose subordinate voting shares provide one vote per share, while the founders and insiders hold a different class of shares that provide 10 votes per share.
Simply put, the ISG feel this share structure is unfair to other investors and this practice should be eliminated. However, there’s one very big problem with the ISG’s argument.
Power.
The institutional investors want what they don’t have, which is a seat at the table. If they were truly concerned about shareholder equality, the ISG would have a corporate governance principle that says institutions holding 10% or more of a company’s stock be allowed to elect someone of their choice to the board of directors — that someone being a representative from a client company.
So, for example, if BlackRock owned 10% of Freshii, BlackRock would go to one of its biggest clients and ask that they submit a name of a person willing to sit on Freshii’s board.
But you and I both know they wouldn’t do that, because it’s not in BlackRock’s best interests. This issue of dual-class share structures, in my opinion, has less to do with shareholder rights and more to do with asset managers seeking a greater say in the business operations of the companies they’ve invested client monies.
It’s a subtle distinction, I realize, but given what’s happening in the U.S. under the newly elected president, I’m loathe to give more power to asset managers than they currently already have.
Besides, performance data suggests that companies with dual-class share structures actually do better than the benchmark indices.
Ryan Modesto is a portfolio manager with 5i Research in Kitchener, Ontario. In April 2016, he contributed an article to the Globe and Mail that examined this very issue. His argument is pretty straight forward.
Companies, dual class or not, succeed or fail based on their management team. There are excellent management teams with dual-class share structures — think Prem Watsa and Fairfax Financial Holdings Ltd.—and there are companies with one-share, one-vote share structures whose management can’t find their way out of a paper bag.
It cuts both ways.
Galen Weston, Jr., recently wrote an article for Canadian Business magazine that discussed the special quality of family-controlled businesses using his own experiences at Loblaw Companies Limited (TSX:L) and George Weston Limited (TSX:WN) to make the argument they engender long-term thinking.
Loblaw’s $12 billion acquisition of Shoppers Drug Mart in 2014 is a perfect example. Under a hired-gun CEO, the acquisition might not have happened, reasons Weston, because the board of directors wouldn’t have allowed it to; controlling Loblaw’s common stock enabled it to get it done — a deal I believe was transformational to the company.
Now, Loblaw and George Weston don’t have dual-class share structures, but when the Shoppers deal happened, the Westons owned 63% of Loblaw through George Weston. Control is control. Whether these two companies had dual-class share structures or not, the move was a good one made by a good management team who thought bigger picture — a trait not found in many public companies.
Oh, and in case you’re wondering, the 24 stocks in Modesto’s dual-class share structure delivered five- and 10-year annualized returns of 4.2% and 3.7%, respectively — 520 basis points and 260 basis points greater than the TSX.
Dual-class share structures allow for long-term thinking. They are not the enemy. Bad managers are.
