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This post is authored by Shashi Shekhar, 3rd year B.A. LL.B (Hons.) student at Faculty of Law, Banaras Hindu University.
1. INTRODUCTION
In financial law, promoters and founders have always sought to maintain control over their companies. However, when companies rely on equity shares for their capital structure, promoters face significant ownership dilution and reduced control. In corporate scholarship, there have been many experiments and brainstorming on developing safeguards to retain control over the company even with a capital structure based on equity shares. One of such safeguards that rejuvenated with big tech giants like Google going public, is the dual-class stocks (“DCS”) or shares with differential voting rights (“DVRs”). DCS structures facilitate companies to raise capital without losing control, which is done in either of two ways: (i) retaining shares with superior voting rights, as this would give excessive voting rights, say, and thus dominance in control of the company; or (ii) issuance of shares with lower or fractional voting rights to public investors.
Based on their purpose and the object behind building the type of capital structures they form part of, it can be said that the dual-class shares are essentially to allocate superior or disproportionately excessive voting rights to insiders and inferior or less than ordinary voting rights to outsiders, where insiders and outsiders are two species of investors buying shares of a company and thus being given voting rights. With the ordinary norm being that each share should carry one vote, superior voting rights mean when an investor is given the right to more than one vote on one share and, on the other hand, inferior voting rights mean the right that entitles the investor to less than one voting right for one share.
2. THE GLOBAL PERSPECTIVE
The entire corporate world may be divided into two fragments: one, which allows the issuance and listing of shares with DVRs, and the other consisting of those jurisdictions that do not permit dual-class shares. The reasons for allowing or not allowing dual-class shares are multi-fold and vary in different jurisdictions. The case of the United States can set a good starting point for the analysis of the tenability of dual-class shares across different jurisdictions. The development of devices to centralize voting control began in the U.S. in the early twentieth century. Initially, the New York Stock Exchange (“NYSE”) remained committed to its “one share- one vote policy” and did not permit the listing of stocks of those companies that issued different classes of shares, some being with no voting rights and others with unequal voting rights. Its policy was to encourage high standards of corporate democracy and accountability to shareholders.
The trend of multiple-class shares in the U.S. has to be attributed to Google’s decision to go public with a dual-class capital structure in 2004[1] in which shares owned by the founders conferred greater voting rights, more than 61 percent, than shares issued to public investors[2], which further led to other companies like Facebook, LinkedIn, and Groupon deciding to go public following a multi-class capital structure that enabled them to retain their control over the company. Since the United Kingdom and Hong Kong prohibited the use and listing of DCS shares, the trend in the U.S. set in motion largely by Google in 2004 even attracted non-U.S. companies like Manchester United and Alibaba Group Holding Ltd. to list their stocks on the NYSE.
In the U.K., it was generally held view in the investment community that DCS structures deliberately block takeovers, which led to their primary exclusion.[3] Prior to December 2021, companies seeking listing on the Financial Conduct Authority's (“FCA”) Official List's premium segment were prohibited from adopting a dual-class share structure, although this limitation did not apply to those listing on the FCA's standard segment. Nevertheless, in December 2021, the FCA implemented a specific and time-constrained form of dual-class share structure for premium listings[4]. Recently, in 2024, DCS structure in U.K. has witnessed innovative developments and approach towards it being made even more flexible.
The Australian Securities Exchange does not allow the listing of stocks of the companies offering non-voting shares or superior voting shares. However, unlisted companies have more flexibility in this regard to the extent that they may provide shares with limited or disproportionate voting rights. Interestingly, Europe has always been comparatively welcoming of the DCS structures, which is evident from the fact that in many countries, such structures have been relatively common, though they have varied in their prevalence. However, due to diverse national business cultures and variance in how DCS structure prevails in different countries in Europe, it has been difficult to harmonize the takeover laws.[5]
The abovementioned approaches of various jurisdictions towards multi-class capital structures make it clear that “one share – one vote” remains the optimum method of empowering shareholders and fixing accountability of the owners/promoters to shareholders, thereby encouraging corporate democracy.
3. UNTENABILITY OF DVRS AND WAY FORWARD
The analysis begins with considerations that make the concept of dual-class or multi-class capital structure based on shares with DVRs, a not-so-tenable one in the financial and corporate landscape of this country. At this juncture, what is to be understood is what sort of businesses and companies dominate the Indian market and what their ownership looks like. For instance, according to a 2017 Credit Suisse report[6], with a market capitalization of 6.5 billion dollars, India has the third-highest number of family-owned businesses. In India, concentrated ownership and control are more often the rule than the exception. The prohibition on the issuance of shares with DVRs is generally understood to serve the dual purpose of preventing the possible misuse of such structures by persons in control and safeguarding the interests of public shareholders. Evaluating the DCS structure has to be premised upon the understanding as to why the DCS structure is needed by companies. After the IPO stage, companies seek to prevent their decision-making and control regime from getting influenced by the wide array of voices of public shareholders and immunize their idiosyncratic vision and objectives from being hijacked or maybe lost in the wide range of narratives that public shareholders carry with them. However, these considerations yield to the concerns raised by the investment community around corporate governance, shareholder democracy, and accountability to shareholders.
Research published by the Investor Responsibility Research Centre and Institutional Shareholders Services finds that in the long run, companies with DCS structures, when compared to companies with “one share - one vote” structures have shown worse economic results. DCS structures grant disproportionate voting power to select shareholders, often leading to a lack of accountability. While proponents argue that these structures insulate corporate decisions from short-term market pressures and empower visionary leadership through DVR shares, these claims often lack substantive evidence. In reality, the absence of checks and balances means investors are left with little recourse to hold management accountable for poor decisions. This dynamic fosters a governance gap, where controllers are insulated from market discipline, enabling them to act in ways that may not align with the interests of public shareholders or the broader market.
Many countries that have adopted a restrictive model for dual-class shares have implemented stringent corporate governance rules[7] to safeguard shareholders' interests. This approach is particularly crucial in companies with dual-class share structures, where public investors inherently possess reduced influence over corporate decisions. In India, the SEBI (ICDR) Regulations, 2018 specifically address this concern by mandating that newly issued shares must be pari passu with existing shares in all respects, including dividend rights, ensuring at least economic equality among shareholders despite differences in voting power.
Moreover, research has shown that the lack of accountability in DCS structures can lead to entrenchment, misaligned incentives, and inefficient allocation of capital. For example, a 2018 study by the Council of Institutional Investors[8] highlighted how companies with perpetual DCS structures risk poor long-term governance outcomes. Critics also emphasize that such structures can lead to conflicts of interest, where controllers prioritize personal goals over shareholder value, exacerbating governance risks.
A significant issue with implementing the DCS structure is the potential for its disadvantages to grow and its advantages to diminish as time passes after the initial public offering. Consequently, there is an increasing likelihood that a dual-class structure may cease to be an efficient capital structure over time[9], even if it was initially beneficial. Notably, even critics who reject the implementation of dual-class share structures altogether believe that if companies are allowed to go public with such arrangements, these capital structures should be coupled with suitable sunset clauses[10]. Sunset clauses may alleviate concerns regarding increased risks and costs over time that arise when a DCS structure is not made to terminate generally after the IPO. Sunset clauses outline the process and, in some cases, the timing for ending dual-class share structures, resulting in the conversion of all shares into a single class.
Notably, in regions where investors consider it impractical to eliminate DCS structures, the implementation of optimal sunset provisions is seen as a potential solution to address major concerns. Companies utilizing these structures have incorporated various sunset provisions, including: (i) fixed-time sunset; (ii) triggering event sunset; (iii) ownership percentage sunset; and other sort of sunset provisions. To mitigate risks associated with DCS structures, safeguards can be established during the IPO stage by mandating companies to disclose: (i) how these structures align with and support the founder's vision and if such vision is to enhance corporate value; (ii) that there exist mechanisms to ensure founder accountability; and (iii) the impact of promoters breaching their fiduciary duty (as imposed by fiduciary sunsets[11]) which they owe to public shareholders on their control of the corporation.
4. CONCLUSION
The debate surrounding DVR shares reflects a fundamental tension in modern corporate governance - balancing entrepreneurial control with investor protection. While DVRs offer founders a means to raise capital without diluting control, evidence suggests they may lead to suboptimal economic outcomes and governance concerns in the long run. The solution appears to lie in structured safeguards, particularly well-designed sunset provisions, rather than outright prohibition or unrestricted adoption. Moving forward, regulatory frameworks must strike a delicate balance between fostering innovation and entrepreneurship while ensuring adequate investor protection and corporate accountability. The “one share - one vote” principle, though challenged by DVRs, remains a cornerstone of sound corporate democracy.
[1] Mukherjee D and Pandey A, “Private Control with Public Money: How Far Can We Go?” (Vidhi Centre for Legal Policy 2019) <https://vidhilegalpolicy.in/wp-content/uploads/2020/06/DVRReport-Final.pdf> accessed January 10, 2025.
[2] Solomon D, Palas R and Baranes A, “The Quality of Information Provided by Dual-Class Firms” (2020) 57 American Business Law Journal 443 < https://papers.ssrn.com/sol3/papers.cfm?abstract_id=4056471#paper-citations-widget > accessed January 12, 2025.
[3] Mukherjee D and Pandey A (n 1) 9.
[4] Roe J, Bloch M and George C, “UK Listing Rules Reforms: Controlling Shareholder Regime and Dual-Class Share Rights” (A&O Shearman, February 5, 2024) <https://www.aoshearman.com/en/insights/uk-listing-rules-reforms-controlling-shareholder-regime-and-dual-class-share-rights> accessed January 20, 2025.
[5] Hayes, Samuel L., III, Lynn S. Paine, and Christopher Bruner. "Dual Class Share Companies." Harvard Business School Background Note 306-032, August 2005.
[6] Dimson E, Marsh P and Staunton M, “Credit Suisse Global Investment Returns Yearbook 2017 Summary Edition” <https://engineeredportfolio.com/wp-content/uploads/2017/07/credit-suisse-global-investment-returns-yearbook-2017-en.pdf> accessed January 19, 2025.
[7] Gurrea-Martínez A, “Theory, Evidence, and Policy on Dual-Class Shares: A Country-Specific Response to a Global Debate” (2021) 22 European Business Organization Law Review 475
[8] Mirchandandi B and Tellez V, “ Making the Call: The Role of Long-Term Institutional Investors in Activism” (FCLTGlobal 2020) <https://www.fcltglobal.org/wp-content/uploads/Making-the-Call-The-Role-of-Long-term-Institutional-Investors-in-Activism_FCLTGlobal.pdf> accessed January 19, 2025.
[9] Bebchuk LA and Kastiel K, “The Untenable Case for Perpetual Dual-Class Stock” (2017) 103 SSRN Electronic Journal.
[10] Mukherjee D and Pandey A (n 1) 5.
[11] Winden A, “Sunrise, Sunset” (2018) 2018 Columbia Business Law Review 929.