Approximately 8% of the S&P 500 and 9.4% of the Russell 3000 have multi-class share structures with uneven voting rights between or among the series or classes of shares. Since January 1, 2021, 26.4% of non-SPAC IPOs in the US have had such multi-class capital structures. In 2023, S&P Dow Jones Indices reversed its position from 2017 that companies with such multi-class share structures would be ineligible for new entrance into the S&P Composite 1500 and its component indices, which included the S&P 500. Academic studies continue to wrestle with assessing the extent of any nexus between such multi-class structures and positive or negative performance trends.
Yet institutional shareholders and governance advocates continue to try to pressure companies to unwind multi-class arrangements. For example, in the last three years, 25 non-binding shareholder proposals to unwind multi-class structures were submitted to stockholders of US public companies, and, while they inevitably fail to pass due to rejection by the high vote holders, they nonetheless typically receive support from a supermajority of the low vote holders.
These multi-class structures certainly have the ability to insulate boards from proxy fight losses and hostile takeover vulnerabilities, but they do not necessarily insulate companies from shareholder activism. Activists are keenly aware that many independent directors will, from time to time, prefer to reach a conciliatory settlement with an activist even if the activist’s chances of winning a proxy fight are remote or even zero. No non-management director likes to be personally attacked publicly and no executive team relishes the distraction of defending its board against public attacks. Moreover, occasionally boards and the high vote holders conclude that the economic upside (i.e., the bump to the stock price) that would result from the unwinding mutli-class structures outweighs the benefits of stability and long-termism that support decisions to adopt and maintain such multi-class structures.
Removing the multi-class discount may increase valuation in the near term if the holders of the high vote stock are viewed by the market as both exercising a degree of control and impeding share value-enhancing alternatives, such as openness to a sale of the company.
In these scenarios, boards may negotiate with high vote holders a reclassification transaction where all the high vote shares convert into low vote shares at a premium to the exchange ratio that would otherwise apply. The objective is for the premium to be low enough that the low vote holders will still benefit from an increase in the trading price attributable to the reclassification transaction’s conversion (albeit at a premium) of all the high vote shares to low vote shares.
Among the factors that will make an issuer more or less ripe for a reclassification transaction and that merit taking into account in any negotiation or consideration of such a transaction is the magnitude of the equity position (disregarding voting power) represented by the holdings of the high-vote control group. The smaller the equity position, the easier it may be to provide the high vote-control group with a generous exchange ratio that still leaves lots of room for all the low vote shares to benefit from a trading multiple expansion triggered by the reclassification’s elimination of the overhang of control.
While there are procedural hurdles for any related party transaction with a controlling holder such as a reclassification, these hurdles are far from insurmountable. In fact, the roadmap for transactions between a company and its control group, laid out in the newly amended Section 144 of the Delaware General Corporation Law would insulate the controlling stockholder and the board from fiduciary duty claims and entire fairness review if an informed committee of independent directors negotiates in good faith and without gross negligence the reclassification transaction on behalf of the company. Most charters will further require approval by a majority of the low vote shares, as well as a majority of the high vote shares, each voting as a separate class – which approvals, by themselves, would be sufficient to qualify for the Section 144 safe harbor from fiduciary duty claims even if there were no independent committee approval.
Factors that may make a multi-class company less ripe for a reclassification transaction include:
- Minority protections under the multi-class structure, such as the reservation of board seats and other matters for class votes of the low vote holders
- Sunset provisions for the multi-class structure (e.g., as a result of the death of the members of the control group or a near-term date)
- Failure of the dual class to entrench control of the company by any group—e.g., if the high vote shares are freely tradeable and are increasingly held by entities and individuals who do not act in concert or conscious parallelism
Multi-class structures with uneven voting rights are necessarily neither a vice nor a virtue. When such a structure ceases to be economically rational, a relatively easy escape valve exists and, most importantly, incentives for the control group to head for that exit become palpable.
