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S&P votes ‘no’ to no-vote shares

Companies with dual-class structures impose a disproportionate amount of economic risk on public shareholders in relation to their voting power. But thanks to the actions of global index provider S&P Dow Jones Indices, at least one key player in the chain of corporate accountability is standing tall.

In the latest iteration of dual-class capitalizations, Snap Inc. took shareholder disenfranchisement to new lows. Snap famously offered shareholders zero votes per share as part of its recent initial public offering, the nadir of a recent trend of companies testing the limits on shareholder rights.

Snap's action caused an outcry among institutional investors, particularly as it relates to the prospect of these no-vote firms eventually making it into key market indexes. Many such institutions are largely index investors and own huge positions in funds based on the indexes of firms like S&P Dow Jones, FTSE Russell and MSCI Inc. But proponents of investor rights, who have fought long and hard for the rights of shareholders in public companies, rallied support against the governance scofflaws. In response, three index providers opened consultations asking for investor comment. The MSCI comment period is open until the end of August, but S&P and FTSE have taken action.

S&P took what we consider to be the hallmark approach. It will not allow companies with dual-class share structures to be part of some of its high-profile indexes such as the S&P 500 and its small-cap and midcap brethren. Companies already in the index with dual-class share structures will be grandfathered.

Meanwhile, FTSE chose to adopt a lower threshold, stating that companies will only be required to give shareowners a cumulative voting power of 5% of a company's shares in order to qualify for FTSE Russell indexes. While better than nothing, from an investor protection/shareholder rights perspective, it's not sufficient. The FTSE Russell announcement does state the proposal is subject to modification based on public reaction to the proposal. We strongly encourage all three of the major index providers to send a strong and consistent message to companies trying to access public capital.

Hot button

The proliferation of dual-class shares is one of the most hotly debated corporate governance issues globally. The cutthroat, nationalistic competition inspired by IPO listings is palpable. Recall that Alibaba chose not to list on the Hong Kong Stock Exchange because the exchange would not allow the dual-class shares Alibaba management preferred. Now, both Hong Kong and Singapore are debating whether to allow dual-class shares for IPO companies, with Singapore already deciding to allow dual-class share structures for companies who choose Singapore for a secondary listing. In 2014, the French government signed into law double-voting rights for shareowners who hold shares for two years or more unless the bylaws of a company prohibit such a structure.

Defenders of dual-class structures say that such structures allow management to focus on the long term without having to worry about short-term pressures from shareowners. This is not the case in practice, however. Dual-class share and voting structures are favored by management because they allow management to have their cake and eat it too. Multiple studies show dual-class shares tend to underperform because they tend to entrench management and boards, and eliminate the corrective measure of investor pressure when a strategy or business plan is just not working. The CFA Institute sponsored a recent study on dual-class share structures in Brazil, and found dual-class companies generally underperform their peers with one-share, one-vote structures. To those suggesting these index exclusion moves will disadvantage retail investors, we say nonsense. These IPOs will still happen and be available to any investor, although dual-class companies will not be allowed to slip their substandard governance into a widely used market index.

Not being included in a major index such as those offered by S&P Dow Jones, FTSE Russell and MSCI is a big deal. Companies like Snap will miss out on the automatic demand for their stock by index funds, which will doubtless serve as a drag on the stock prices of the excluded companies. But it is an even bigger deal for investor protection, transparency and shareholder accountability.

Thanks to the actions of S&P and hopefully other index providers, it looks like the price of poor corporate governance just got higher.

Bjorn Forfang is managing director, CFA Institute, New York. This article represents the views of the author. It was submitted and edited under Pensions & Investments guidelines, but is not a product of P&I's editorial team.